Fiscal Credibility

To restore its fiscal credibility within global financial markets, the Coalition has set itself the political goal of eliminating the current structural deficit (11% of GDP) in the UK by the end of this parliament (2015). Ed. Balls now shadow education secretary but with a major economic influence on Gordon Brown in the last government, has responded with what seems a rather self-serving attack on this planned deficit reduction programme, when linked to his ambitions as a candidate in the current Labour leadership contest and an associated need for public-sector union votes.
According to Mr Balls, there was no significant structural deficit until the collapse of tax revenues from the financial sector in 2008, although the Office for Budget Responsibility (charged with an independent watch over government fiscal policy) has this deficit already averaging 2.7% of GDP (£40 billion) from 2003 onwards. He had even warned the previous Labour chancellor Alistair Darling, that his planned £73 billion of fiscal tightening (of which £52 billion was in reduced planned public spending) to try and only halve the deficit over four years, was a mistake. Although seemingly ignoring the negative effects of the financial markets on the credit rating and associated elevated borrowing costs of the UK government, he is on the side of the more Keynesian economists who argue that the aggressive cuts planned by the Coalition will severely undermine the recovery. Indeed, he is advocating for the UK economy the example of the US which to date, despite its large deficit, has hardly tightened fiscal policy with almost US$1 trillion of financial stimulus and additional proposals from President Obama for e.g. US$50 billion of extra spending on infrastructure. The latter is viewed as key to supporting more rapid economic growth in the future. In the UK, the Confederation of British Industry (CBI) for the employers supports this case in warning against large cuts in spending on roads and rail.
The problem for the UK is that it is not as fortunate as the US which has in its favour the US$ as the major reserve currency in global financial markets, should the US choose to continue to try and spend its way to economic recovery. That is, unless the Chinese government, with its huge foreign currency reserves in US$, decides for geopolitical reasons to severely undermine the value of its US government bond holdings through a major sell-off. In the case of the UK, according to the Institute of Fiscal studies, a policy of ignoring the financial markets and rating agencies, together with continued borrowing instead of cutting public services and projects, would result in a deficit of 7% of GDP by 2015 and total public debt rising unsustainably towards 100% of GDP and beyond.
Within Europe in comparison, a country such as Germany with a deficit below 4% and a booming export sector has much more fiscal space should it so choose, to stimulate demand in its domestic market and at the same time drive overall growth within the Euro-zone and the EU. However, Germany with a memory of the effects of hyper-inflation not that far in its past, prefers savings and investment over the seemingly unrestricted consumer borrowing and spending of its more profligate neighbours, who should first put their own houses in order.

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