George Osborne wants to burnish his image as an iron chancellor of the exchequer. He has already committed to achieving a fiscal surplus by 2019-20. He now suggests that further tightening of fiscal policy may be needed in response to the “storm clouds” he identified when in Shanghai last week. Mr Osborne may be preparing for bad news in his Budget on March 16. The question is whether his plan makes sense. The answer is no.
The fiscal objective is itself questionable. The aim is to achieve an overall surplus, unless growth drops below 1 per cent. This is to offer respite in the event of a recession. Just compare what the government would do if a deficit opened up while the economy grew 1.1 per cent for three years (namely, tighten policy), with what it would do if it grew 3 per cent, 0.9 per cent and then 2 per cent (not tighten at all in the second year).
Why should an overall fiscal surplus be important, anyway? The answer is that it is a quicker way to lower the ratio of debt to gross domestic product. But that would only be true if achieving the surplus did not itself slow the growth of GDP. As the Institute for Fiscal Studies notes in its Green Budget, “running a surplus is not necessary to bring debt down as a share of national income”. Moreover, if the government is in a position to invest by borrowing at low real interest rates, as now, it makes sense to do so. The government must worry about its balance sheet, not just its debt.
Yet the absurdity of the target is brought out better still by the comments Mr Osborne made last week. He said, first, “this country can only afford what it can afford”; second, “the economy is smaller than we thought”; third, the UK must tighten further, to ensure “economic security”; and, finally, “the last time we didn’t [live within our means] we were right in the front rank of nations facing economic crisis”. This is bad history and worse economics.
It is a myth that the UK’s crisis was due to a failure of the government to live within its means. The truth is the opposite. The government did not have a fiscal crisis. The country had a financial crisis whose economic results were cushioned by the government’s deficits.
Again, it is not true that running a fiscal surplus year after year is either necessary or sufficient to achieve “economic security”. It is more important to create a robust financial sector. Yet pressure from the Treasury today seems to be to relax constraints. That may well be far riskier for the UK economy in the long run than modest fiscal deficits.
It is, above all, not true that the government should respond to a (possibly) temporary slowdown, particularly one due to external factors, with a permanent fiscal tightening. Nothing happening in the past few months should reshape our view of output years hence. The economy might be smaller today than we expected. But that does not mean it will also be smaller in 2019-20.
Moreover, Mr Osborne constantly and presumably deliberately elides the country with the government. The country as a whole runs a current account deficit of about 5 per cent of GDP. In aggregate, then, it surely “lives beyond its means”. It will continue to do so, whatever Mr Osborne does about fiscal policy. The chancellor does not care about this. What matters to him is just what the government does.
Yet, by ignoring what is happening in the private sector, Mr Osborne might even be increasing the risks to the economy. By tightening fiscal policy, he puts more pressure, other things being equal, on monetary policy. Monetary policy works by encouraging lending and raising asset prices yet higher. It is quite easy to imagine that the latter effects would worsen the “security” of the economy by more than a slightly larger fiscal deficit. In brief, the elision of the country with its government is not just a rhetorical trick, but an analytical mistake. It rules out, by definition, the possibility that a tighter fiscal policy might destabilise the economy, once the full consequences, including the monetary consequences, are taken into account.
Finally, the statement that “this country” (by which the chancellor means the government) “can only afford what it can afford” is quite as circular as it seems to be. What the government can afford is precisely what is up for debate. At present it can afford to borrow a great deal, because it is so cheap.
One can see two ways of understanding the chancellor’s words. The first is that he seeks an excuse to cut spending further. The other is that he is now hoist by his own petard. Having committed to a fiscal outcome by a given date, he is (for now, at least) prepared to do whatever it takes to achieve it. “Never give a date and a number” is sage advice. Mr Osborne should have remembered it.
