Just suppose George Osborne had been run over by a bus the day after the election and in his grief Cameron had given the Liberal Democrat leader a proper job. The reason for concocting this fantasy is that people still say to me that George Osborne - given the situation at that time - had to do more about the deficit. It is only in hindsight (following the 2011 insights of Paul de Grauwe, followed by OMT in 2012) that we know the Eurozone crisis was special and so UK austerity was unnecessary. I do not accept that view, but the point I want to make in this post is that even if you do, it does not excuse Osborne’s actions.
Suppose that in 2010 we had had a UK Chancellor who was seriously worried about market reaction to the deficit, but who was also concerned about the recovery. What might they have done? (I cast Clegg in this role, although Vince Cable might be able to play it with more conviction.) The first thing Clegg might have done is to get the ‘huge’ deficit number in perspective. Here is the data.
|UK Net borrowing requirement, % GDP (Source OBR)|
The size of the deficit in 2009/10 (10.2%) was unprecedented, but not so very different from the deficit in the ‘ERM recession’, and of course the 2009 recession was much larger. So panic was not required. (The nice Mr. King was already buying lots of government debt, so there was no chance of running out of money whatever the markets did.)
The second thing Nick Clegg might have done is ask Mr. Budd (temporary head of the newly created OBR) how confident he was about the forecast recovery. Alan Budd would have done what all good forecasters do, and emphasise how uncertain macro forecasts are. So there is a real possibility that the recovery might come to a halt, Nick might ask. Absolutely, Alan would reply, particularly given what is going on right now in the Eurozone. He would then ask Mr. King how confident he was that Quantitative Easing could save the day if that possibility came to pass. Mr. King would in all honesty say that while they would do their best, he had virtually no idea what impact this new monetary instrument would have, so he could not guarantee anything.
So Mr. Clegg is left with a dilemma: any action taken to reduce the deficit might put the recovery at risk. But all was not lost. First, the clever Rupert Harrison who used to advise George before that unfortunate accident had come up with quite a nifty fiscal rule that required hitting a target for the current budget in five years time. This had two advantages. First, austerity could be back loaded to give the recovery the best chance of taking off. Second, the rule did not include public investment. Now the chaps at the Treasury said that the multiplier from public investment was pretty high, so Nick asked them to keep those public investment numbers up for at least the next three years. (He might have added, given his colleagues knowledge, be sure to increase work on flood defenses.)
But both the guys at the Treasury, and Mr. King, might have said that postponing all the deficit reduction until after 2011 would not be credible. OK, Nick might have replied, but what should I do straight away: cut spending or raise taxes? The Treasury people would have said that if the aim was to protect the recovery, tax rises - particular on the better off - would be preferable, because some of those would come out of savings rather than reduce demand. So raise taxes first, perhaps on just a temporary basis, and replace them with spending cuts later on. Which taxes, Nick might ask? At this point Mr. Harrison might recall a conversation he had had with an Oxford academic. If you want to impress the markets that you have got what it takes to control the deficit, do something straight away that incurs large political costs. Did he have a specific suggestion? Nick asks. He did suggest increasing inheritance tax, Rupert responds sheepishly, but I think he had George in mind at the time. Sounds good to me, says Nick.
OK, I’m getting carried away here, but I hope you get the idea. An austerity plan could have been devised which tried to protect the recovery as much as possible. In particular, public investment could have been kept high, but what actually happened was it was cut substantially. What we got were fiscal actions that seemed to completely ignore the fact that we were just emerging from an unprecedented recession. When interest rates are at the Zero Lower Bound that is bad policy making and it had large costs.