Can 77 Economists get it Wrong?
Posted by rantingkraut on April 15, 2010
Apparently 77 economists have sided with Brown in the following letter:
“As expected, a key election issue concerns how much to cut government expenditure in 2010/11. The main opposition party now proposes to cut an extra £6 billion in 2010/11, on top of the measures already planned by the government. This cut is described as efficiency savings. But in macroeconomic terms it is just a cut by another name. It will lead directly to job losses and indirectly to further falls in spending through the standard multiplier process. At a time when recovery is delicate, it could even affect confidence to the degree that we are tipped back into recession – with much larger job consequences.
Not all of the signatories are leading economists, but some of them are. There are also some obvious objections to the arguments made.
One need not be a Keynesian to believe that short term dynamics matter at the onset of a recovery. You need to be an optimist though to expect further increases in debt financed spending to sustain the UK’s recovery at present.
There are two obvious objections:
1. Ricardian Equivalence: formally, this means that people will anticipate the future tax burden that will be imposed on them by today’s debt financed government spending. Since they will have to pay more taxes tomorrow, they will cut back their spending today. Of course, few people will engage in formal forecasting, but a massive public debt build-up like the present one should be likely to produce widespread expectations of future tax hikes.
2. As government debt becomes extremely high, investors will worry about its sustainability. This can drive up risk premia on government bonds and by implication on other assets. High interest rates will of course make investment more costly and therefore weaken the recovery. It seems reasonable to assume that the UK and Greece are now among the countries where debt sustainability is becoming a problem.
Whether or not you should expect the 77 economists to be right crucially depends on your view of public debt. I don’t think the UK can afford more debt at the moment and therefore I think the 77 are wrong, even though in general and with a less dramatic situation in public finances they may have had a point.
(The text of the economists’ letter -unlike the Times headline- does not explicitly mention national insurance. I therefore argued on the assumption that they are discussing debt financed spending. National insurance financed public spending would of course not produce direct additions to debt. It would merely distribute income from one party to another while incurring administrative costs and increasing the cost of employment in the private sector. How this should support the recovery is beyond me -even by the internal logic of Keynesian reasoning.)
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