David Willetts, who I have generally found to be pretty sensible, praises Hammond’s Autumn Statement in the FT as casting off Osborne and Treasury orthodoxy. This is the same Autumn Statement that I described as a return of austerity: wasting resources by cutting spending when interest rates are at their lower bound. I think these two different views of the same event can be explained by an analogy.
Imagine four different reactions after a fire breaks out.
The house is fitted with a sprinkler system which puts the fire out pretty quickly
There is no sprinkler system, but the house owners find every drop of water they can, using buckets and hoses, to put it out
The owners get one bucket, but only ever fill it half up because water is not free
The owners do nothing: the fire will soon burn it itself out, they say, and water needs to be conserved.
In case it is not obvious, the fire is a negative output gap - wasting resources - and water is the deficit or debt. David Willetts is praising Hammond for moving from (4) to (3). Instead what he and the Treasury should be doing is (2), and then installing (1), which if you haven’t guessed is analogous to a fiscal rule with a zero lower bound knockout.
I know the Conservatives will not do (1) until this generation of politicians have passed, because it would be an implicit admission that 2010 austerity was a mistake. I also know that Labour is committed to such a fiscal rule.
Hammond may get lucky, and economic growth could be much stronger than forecast such that the MPC soon stops QE and raises rates. In my analogy, the fire might not spread. But policy should always take account of reasonable risks, and the probability at the moment is that we will stay at the lower bound for some time. The official output gap may be small compared to 2010 (although I worry it might in reality be a lot larger), but if you discovered a fire in your house what would you do?