Osbornes Balanced Budget Proposal Is A Very Bad Idea

Osborne's Balanced Budget Proposal Is A Very Bad Idea

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And there I was naively thinking that conservatives and right-wingers have some degree of respect for markets.

George Osborne's latest deficitphobic scheme to make running a government deficit during what he defines as "normal times" illegal is at best an ill-conceived political ploy designed to make the country more Tory. The logic goes: shrink the public sector, and watch the private sector grow, and because private sector workers vote Tory at a higher rate than public sector workers, watch the Tories win more elections. 

At worst, it's a downright dangerous attempt to introduce an arbitrary cap on the government's ability to create the infrastructure and public services the country needs to function.

Ignorance is often fashionable, and so it has become with the politics of the deficit, both in Britain and on the other side of the Atlantic. The Tories won the election on the back of gross public ignorance on the state of public finances: the fashionable nonsense that governments should be revenue constrained. As financial adviser Adrian Gill argued on Question Time and in the Mail during the run up to the election: "if I get to the end of the week and find I don’t have enough money for a pint, then I’ve spent too much."

In these neo-Victorian times, is fashionable to think of the public finances in this manner: as very much like a household budget. But, of course, it is also totally erroneous to do so, no matter how many times and how strenuously you repeat the mantra "you can't spend more than your income."

Are households the sovereign issuer of their own currency? In other words, do they have the ability to print more money (in which their debt is denominated) out of nowhere? No? Then they are nothing like a monetarily sovereign government.

Is there a massive (multi-trillion) and liquid (billions of dollars of transactions per day) and massively discounted market for the debt of any household? No? Then they are nothing like a monetarily sovereign government.

And what household is responsible for the creation of national infrastructure and public goods (roads, bridges, airports, sewage facilities, internet connectivity, national defence, welfare safety net, etc)? The government budget is a major (if not sole) determinant factor for all of these requirements. This alone makes government budgetary activities far removed from household ones. It is like comparing a board game like chess with a real war. There is some superficial surface similarity, but knowing about board games doesn't mean you have any understanding of the pragmatic realities of managing an army in the field, managing resources and winning a war.

Government can easily (and relatively cheaply compared to households and private businesses who have to borrow at a premium) spend more than its current income. And the burden of being the major (if not sole) infrastructure and public goods provider means that sometimes (for example, when infrastructure is crumbling) major investment is necessary to support growth irrespective of current fiscal revenues. (Remember that the deficit is paid back with future tax revenues which tend to be larger in absolute terms due to economic growth, not current ones, so comparing today's deficit to today's tax revenue is a rather distorted picture).

The key restraint is the market itself, and it is rather shameful that the right neglects this. Markets provide information to show how much slack there is in the economy, and the government's capacity to deficit spend. The most important question is the affordability of government borrowing. Currently, UK government inflation-adjusted borrowing costs are very close to zero, and thus very close to the lowest rates in history. In other words, the market is willing to give the UK government (in a similar manner to other developed-world monetary sovereigns like Japan, the United States, and Germany) money to invest almost (but not quite) for free. 

That's in spite of all the deficit panic about how the UK has unsustainably high debt levels. The market is offering the money cheap because the market understands in spite of all the deficit panic that the UK has a very low risk of overspending. Not only is the UK a monetary sovereign with the ability to effectively print as much money as it requires, but it is stable, advanced economy with very low current levels of inflation, relatively historically low government borrowing costs as a percentage of GDP, and relatively historically low government debt as a percentage of GDP. I really have no idea what the deficitphobes are panicking about (and nor does Simon Wren-Lewis).

If these indicators changed and the UK was in risk of being in a position where it was "living beyond its means" we would see higher levels of inflation, and the market would demand higher real interest rates to compensate for the additional risks. Government austerity would be expected to remedy that. Actions have consequences. That is the fiscal discipline that every monetary sovereign must live under. Arbitrary rules that try and enforce mass austerity based on today's tax revenue levels — and which the government debt market isn't calling for — are therefore completely pointless at best.

At worst, they could be damaging to economic growth. As John Van Reenen notes, in the Coalition's austerity from 2010, "the OBR estimates that 2% of GDP was lost due to austerity policies (1% in 2010-11 and in 2011-12)". But that's nothing compared to the epic depression ongoing in the eurozone today: Greece, Spain, Portugal. Taking away the government's ability to spend its way out of a depression makes a depression much likelier.

But, as I said, ignorance of all of this is presently fashionable and Osborne has a majority in parliament to set the rules he wants to set. Sometimes farce must turn to tragedy before the ignorant realize the error of their ways.


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