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?
