Full circle on policy? Let's hope so.

[This article appeared first in Public Finance]

The G-20 has come full circle.  In April 2009 in London the talk was of a massive coordinated fiscal stimulus. While this was considerably exaggerated - much of the "trillion dollar package" has already been announced - there was a genuine collective determination to do what was necessary to ensure the financial crisis did not become a prolonged depression.

And it worked, perhaps too well. By June 2010, in Toronto, it appeared that recovery was underway.  The new priority, in what the UK government described as a diplomatic triumph, was fiscal consolidation: the Summit Communique noted approvingly that "advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016."
It is now clear this premature "pivot" to fiscal consolidation, as the IMF described it, was a huge mistake, both for the G20 as a whole and for the UK.  The supposed commitment to halve the deficit by 2013 has been quietly forgotten, derailed by weak growth. At this week's G20 in Los Cabos, the target will, rightly, be growth and confidence, not self-defeating austerity; although it is far from clear that this will translate into meaningful policy.
What does that mean for the UK? Politicians, perhaps even more than the rest of us, like the idea of getting something for nothing. But the Chancellor's Mansion House speech was unusually frank in this respect.  On the one hand, "the costs and risks of discretionary fiscal loosening..are real and significant". So no more borrowing.  But on the other hand:  "we can use the global confidence in our balance sheet to boost private sector growth.  We are already taking action to support new house-building and infrastructure investment through government guarantees.  In the next month we will set out how we can do much more." So much more borrowing, underwritten by taxpayers.  Let's borrow more without borrowing more; more debt is now a good thing, as long as it doesn't count.
The most important point about the speech is that it marks the end of the economic argument about the need for more government borrowing and spending to support demand.  No doubt the Treasury will find a way of ensuring that whatever guarantees are offered have no direct, short-term impact on the deficit, in Treasury accounting terms.  But economically that's irrelevant; there is only a marginal difference between the government borrowing directly from the private sector to finance investment spending, and the government guaranteeing private sector borrowing that finances the same spending.  
Of course, taking the financing off balance sheet just for presentational reasons is non-transparent and potentially costly, as Martin Wolf points out.  The most direct and efficient way to increase spending on infrastructure would be for the government to borrow directly. Indeed, with long-term government borrowing is as cheap as living memory, this is the obvious and economically rational way to go.  Long-term real interest rates are very close to zero - as I pointed out recently, we could finance a £30 billion infrastructure investment plan with the revenues raised from the now-cancelled pasty tax.
But, even within the government's self-imposed restriction to off-balance sheet financing, there are some sensible things that could be done

  • as Tim Leunig and Tim Besley have proposed, the government could kick-start housebuilding by guaranteeing bonds issued by housing associations, secured on the income stream from new houses, and coupled with an innovative approach to ensuring a supply of appropriate land with planning permission.  With housebuilding, especially of affordable homes, at historic lows, while the UK still suffers from a structural shortage of housing supply, this would both boost demand in the short term and benefit the economy over the medium to longer term.
  •  as the ACEVO Commission on Youth Unemployment, of which I was a member, argued, the long-term economic and social damage that will result from current levels of youth unemployment is immense. The government could enable private and voluntary sector providers to invest now in reducing youth unemployment, by promising a substantial future payment stream in return for demonstrated success.  This could in turn enable providers to issue social impact bonds secured on those future payments.
  • the market for loans to small and medium enterprises is dsyfunctional; this both reduces business investment and hence output and employment in the short term, and holds back productivity in the longer term. As Adam Posen at the Bank of England has suggested, the government could unblock the market and increase financing to the SME sector by creating a securitisation vehicle for SME loans. Such securities could then be purchased the Bank of England as part of its quantitative easing programme, again underwritten ultimately by the Treasury.

All of these measures would boost demand, investment and employment. All would of course entail the government assuming some risk. And all would, in economic terms, constitute a "fiscal stimulus".  But none would add significantly to the measured deficit in the short term.  The priority now is for the government to turn words into action. 


Ralph Musgrave's picture

I’m not sure about the idea that government should borrow and invest in infrastructure NOW because of low interest rates. First, those low rates are to some extent artificial: they result partially from the fact that the government / central bank machine has manipulating interest rates downwards so as to deal with the recession.

Second, it has long been accepted that government funded infrastructure projects should be debited with some sort of COMMERCIAL rate of interest, not the rate at which government can borrow. This is because governments have an unfair advantage when it comes to borrowing: they can extort money from the population (via tax) to pay interest and repay capital.

In fact I’d go further, and suggest that, contrary to the conventional wisdom, there is no big merit in funding infrastructure from borrowing rather than from tax. Kersten Kellerman argued this point in a paper in the European Journal of Political Economy. Paper title: “Debt financing of public investment: On a popular misinterpretation of “the golden rule of public sector borrowing”.

Also Milton Friedman advocated a “zero government borrowing” regime. See p.250 here:


Unknown's picture

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Unknown's picture

Whether the rates are low naturally or artificially, those are the rates that the government pays. If we accounted the rate of government borrowing at any rate other than the rate that the government paid to borrow, then government accounts would not line up.

In other words, the government is definitely getting a great deal. You're suggesting that the government shouldn't take the deal because it isn't fair. But nonetheless, they're getting a great deal. If they borrowed to finance infrastructure, or even accelerate already scheduled payments, the tax payer could be getting a great deal too.

(I'd also add that fairness is a concept that has little relevance to economic questions. If we were concerned with fairness more than efficiency we'd have to throw the whole system out anyway.)

Ralph Musgrave's picture

Economics is all about how to most efficiently allocate REAL RESOURCES. Your first paragraph seems to be saying that making government book-keeping entries look tidy is more important than efficiently allocating resources. I find that a very strange argument.

Re your second paragraph, I fully agree that “government is getting a great deal”. The “greatness” of the deal derives, as I pointed out in my earlier comment, from government’s coercive powers: the power to extort money by force from citizens and/or the power to impose artificial rates of interest. By the same token, the Mafia can doubtless get some “great deals” for itself by engaging in extortion and/or imposing artificial prices for various goods. I don’t think that means that the various “deals” done by Mafia make economic sense.

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