The new UK government, which will present its first Budget next Tuesday, has pledged to learn its lessons from the retrenchment in Canada between 1994 and 2000. Good for them: Paul Martin did much right. He realised that, if you are going to rein in a colossal structural deficit, you need a wide consensus. The Canadian regime has also recognised that consolidation requires you to cut where the fat is. It did not salami-slice every budget, but went for where there were savings to be found.
But the Ottawan lesson only goes so far. As Paul Krugman says, it doesn’t help the UK with the macroeconomics of cutting. Its retrenchment took place as the US was booming. The political pain of cutting would have been much higher, the process much more difficult and the results less successful if its giant cousin to the south hadn’t had its nose in the punchbowl.
Britain is going to cut its deficit in what will probably be a weak neighbourhood. German manufacturing has been roaring, but the eurozone is weak and vulnerable. The whole continent’s states are tightening their belts. So while the weak pound might help the UK build market share, the market might be sickly. George Osborne’s confidence that Britain can grow while consolidating looks like hubris.
So what is to be done? Well, the chancellor of the exchequer should press ahead with his ambition to rein in the structural deficit. I don’t really want the government spending more on pay and pensions to prop up output. Stimulus needs to be temporary programmes that come to a defined end. Raising structural spending, only to slash it when the economy recovers, is bonkers. So Mr Osborne should work out temporary packages to offset the deflationary effects of his structural cutting.
Are you going to stand by if the economy goes into a steep decline? … In such circumstances, the most effective instrument might be central bank financing of additional public spending. But your commitment to pre-programmed spending cuts would seem to rule this out. The alternative might be a temporary reduction in taxes, of the kind you condemned under the previous government. In any case, the UK should have a plan for growth of nominal demand at a rate of 6 per cent and preferably more, for some years. Who is to take responsibility for this and how?
There are major attractions to setting out plans for stimulus measures now. Moving towards a clearer rule-based system for discretionary fiscal policy would make it possible to take stimulatory action without spooking holders of gilts. You can make sure they’re ready to go where they’re needed. The Treasury should compile a list of names and addresses to which it could post cheques. In case the UK’s troubles are longer-term, the finance ministry should prepare a list of infrastructure projects it would like to build.
Setting out such contingency plans would require a bit of political bravery. Mr Osborne would be the first chancellor to admit that he is not, in fact, in charge of the economy and not its master. He would be required to admit there is uncertainty in the world and limits to his powers and foresight.
Now that would be new politics.