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| Is there a secret plan B for cutting the deficit? |
Like an ill trained tango dancer the government itself is dancing with the budget deficit and how quickly it needs to be reduced.Should cuts in public expenditure be kept at the same levels as now i.e. an elimination of the structural deficit by the end of the life of this parliament ( Possibly 2015?) or is the medicine killing the patient, with economic growth being relatively flat for the foreseable future.
Since Christmas 2010,on the whole, economic growth has been very disappointing, reductions in public spending do produce an effect on national income which is greater than the value of the intial spending cut. This reduction in spending in the economy is subject to a negative multiplier effect which amplifies
the effect of the spending reduction on national income.
If you are not a Keynesian,then you will always be nervous about having a government budget defcit, even in times of high unemployment, because that defcit needs to be financed,usually by the government issuing UK bonds to foreign investors,including foreign governments. The larger the deficit, the greater the theoretical risk of default, the more that needs to be borrowed externally and the higher the rate of interest that the UK government will have to pay out to foreigners for holding UK bonds. The higher interest the UK needs to pay, the fewer resources it can devote to its own speding programmes. However, probably the most effective way of reducing our external borrowing is to promote higher UK growth,which will mean higher profits and incomes and greater tax revenues for the UK government to utilise in any way it sees fit,usually to redeem existing debt. The problem of low economic growth is therefore directly linked to the speed with which the deficit can be reduced and external debt repaid. The more that deficit reduction and debt repayment can be tackled by higher economic growth the less the requirement for painful public spending cuts.
There is however more to this approach than meets the eye. The public spending cuts are supposed to lead to a position where the private sector can fill the employment and output gap. There is a view that public expenditure crowds out the private sector for example if public spending is higher, then competiton for scare resources is greater,lower public spending means that the private sector will have easier access to these resources,will not be crowded out and will be able to produce greater wealth and employ more people and resources. Such arguments may be valid,but only in the long run, as any such adjustment would take a long time to work through the economy. The private sector will have a big gap to fill and no-one really knows whether it can successfully fill it.
Therefore this week the IMF backed the government's current austerity approach,whilst a deputy director of the OECD intially stated that the UK should think again about a plan B for the economy,before his boss presumably pulled him out of the firing line.
If UK economic growth persists in being as weak as it is at the moment, for say the next 6 months, then George Osborne really will have to think again -- but this will obviously be dressed up as something else under the banner of a flexible response or something like that. The alternative plan B for tackling the UK budget deficit will remain secret for now.
Perhaps the taxation position will be slightly eased or certain public sector projects will be retained.
After all, in 2015 there is an election to be won (or lost?)
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