Have you ever watched two people argue for a while, trying to make up your mind who you thought was right, only to realise both were arguing around the real issues? That is how I feel, having listened to the Government and Opposition on how to deal with the current crisis. Gordon Brown has made the case for an expansionary fiscal policy – pushing money into the economy -– and paying for it later through taxes. David Cameron, on the other hand, has argued for a more long-term approach, demanding that no stimulus come back to haunt taxpayers.
But both have, in a sense, become Keynesians, believing that some kind of stimulus is required to jump-start the economy or, at the very least, preventing it from tanking further. So I have recently been racking my decidedly non-economic brain with the choices presented by the Government and the Opposition. To push for stimulus, damn the long-term consequences and the risk that borrowing might make it harder for the Bank of England to cut interest rates; or to think long-term, with the risk that any fiscal stimulus -– by the nature of it being costed –- will not have any effect. A or B. Brown or Cameron. Government or Opposition.
So far it has not been looking good for the Conservatives. Though I am a fiscal conservative and inherently believe that people more than governments know best how to spend (most kind of) money, Labour does seem to have the rest of the world behind their plans. I hate to say it, but Tom McNulty did score a point against the otherwise excellent Alan Duncan when he told Newsnight watchers that the Tories were alone in the world with their economic policy proposals.
Thinking this through, though, I realised that the choice before us is probably false. Because getting the economy out of its current mess is not necessarily a choice between a reckless stimulus and a balanced stimulus. Instead, the government faces three choices.
The first it to try to get the economy moving again by a clever mix of fiscal stimulus, pumping money into the system (by lowering the interest rates) and giving some people a bit more walking-around cash through tax cuts to boost private consumption. This is probably going to fail as a stimulus will probably not be sufficiently large to have any real impact on the coming recession and would, anyway, not counter-balance the fact that much of today’s economy is build on bad debts and false assumptions. Past experiences of government stimulus have also not had to contend with the problems in the financial sector. In so far that the economic crisis has its roots there, any stimulus will struggle to make a difference.
The second option is to allow for the recession to take hold, which would force bad businesses to close and sustainable ones to survive. This can now been know as the “Maples Model” after the Tory MP who said: “The recession has to take its course… bad debts have to be written off, bad investments have to be written off and people and businesses need to repair their balance sheets.” No government or opposition could say they were pursuing this model — even if that is what they expect to happen if they follow the first option — and John Maples has duly apologised for causing offence to the “victims of the recession.”
This leads us to the third option – courting a gradual, long-term but manageable rate of inflation. Inflation is sometimes referred to as the cruelest tax, but a little inflation is not a bad thing, actually, and even periods that have seen elevated inflation levels produced, on balance, more winners than losers.
In the current situation, inflation might be they best thing to pursue because the biggest problem is all the bad debt floating around, which is making banks cautious of lending. Under inflationary conditions, debtors gain because the debt becomes smaller relative to earnings growth. (The debt is a fixed amount, whereas nominal earnings grow.) Inflation makes it easier for the government to pay off or roll over existing debt at a “real” cost is less than the historical cost. This can facilitate higher rates of economic growth (by virtue of higher levels of nominal spending, and thus stimulus), with reduces real burdens on the Treasury.
Inflation, of course, has a price. Losers during periods of inflation are those who hold non-interest-bearing currency (cash) and creditors whose interest on the loans they charge proves to be less than the current inflation rate. (They lose the difference between the rate of inflation and the rate charged for the loan.) In addition, this model assumes a slow and manageable level of inflation – but who can guarantee that?
Like the “Maples Model”, the “Inflation Model” is politically unpalatable and that is why both government and opposition are busy arguing about the details of the first option, the “Stimulus Model” even though they know that getting out of the current crisis will probably involve a bit from each of the models.
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