The Tories have a problem. The political winds dictate that they retreat from fiscal austerity. But how can they do so without admitting that austerity was an error in the first place? On the Today programme this morning (2’35” in), Nick Boles tried. And failed. Not because of any deficiency on his part, but because he was attempting the impossible.
True, he said much to applaud: that the government must drop the target of achieving a budget surplus early in the next parliament; that the top priority must be to increase productivity and wages; that the government must borrow more to invest; and that increased borrowing is compatible with having the debt-GDP ratio fall over time.
All good stuff.
Except that he tried to reconcile this with the claim that austerity worked. I don’t think the two beliefs are compatible, for three reasons.
First, Boles claimed that increasing investment was ruled out earlier because:
When you have a deficit of ten per cent you cannot possibly splurge on investment because frankly people out there are wondering whether you are ever going to pay your money back.
This rewrites history. In 2009-10 – when PSNB hit 9.9% of GDP – longer-term index-linked gilt yields were at then-record lows of under one per cent of GDP. Such low borrowing rates tell us that “people out there” were not worried about the government’s creditworthiness. They were much more concerned with finding a safe place for their money in the midst of the same recession that caused borrowing to increase. The government could have borrowed more then.
Secondly, Boles says:
As long as you’re spending the money on investment then there’s a very good prospect it will generate a return in the economy that will enable you to pay that debt down.
This, though, is less true now than it was a few years ago. Back then, we had a large output gap: the OBR estimates it to have been between 2 and 3 per cent in 2011-14. That meant that some extra investment spending would not have raised inflation but merely closed the output gap faster. Which in turn means that the fiscal multiplier was probably large then – because there’d have been no offsetting monetary tightening. As the IMF said in 2012 (p43 of this pdf):
In today’s environment of substantial economic slack, monetary policy constrained by the zero lower bound, and synchronized fiscal adjustment across numerous economies, multipliers may be well above one.
Today, though, it’s likely that multipliers are smaller. Last week Bank Governor Mark Carney said (pdf):
The pace at which the economy can grow without generating inflationary pressures has fallen relative to pre-crisis norms. This reflects persistent weakness in productivity growth since the crisis and, more recently, the more limited availability of labour.
This means that any incipient rise in aggregate demand caused by a fiscal loosening will now be more likely to lead to higher interest rates than would have been the case in 2010-14. But this means fiscal multipliers will be smaller now because fiscal policy will be partly offset by tighter monetary policy.
If it is true today that extra investment spending will pay for itself, then it must have been even more true in 2010-14. By this standard, if fiscal loosening is correct today, it would have been more correct five years ago.
Which raises a third problem: why is productivity so weak? It’s at least possible that austerity is partly to blame (not wholly, but partly). As Simon says, weak demand and weak expected demand might have deterred firms from investing and innovating. Unless you rule this out completely – which is difficult - you must admit that austerity was an error.
Now, I don’t say this to argue against a loosening now. Quite the opposite. I still think there’s a case for a mix of looser fiscal and tighter monetary policy, not least because it would get us away from the zero bound. I therefore welcome the sinners that repenteth. But I don’t see that the case is much stronger now than it was a few years back.
Instead, I fear that Tory efforts to defend both austerity then and looser fiscal policy now are mere doublethink – the product of motivated reasoning. We might, though, be seeing a lot more of it. And given our supine media, it will not be sufficiently scrutinized.