Ricardian equivalence

It’s the new year, but the big questions facing the British economy – how fast should it reduce its gaping 13 per cent of national income budget deficit, and how much can monetary policy offset fiscal tightening – remain unanswered.

In the annual FT survey of British economists, the most commonly cited economic threat for 2010 was a fiscal crisis, raising the cost of servicing Britain’s public debt and raising risk-free interest rates, thus undermining the recovery. But economists were split almost 50:50 about how quickly the deficit should be reduced.

On one side of the argument, those urging caution worried about the consequences for the recovery of rapid action in raising taxes or cutting public spending. The counter view was that a failure to act soon will lead to rising costs of servicing debt and that would, itself, undermine the recovery.

I don’t have a good answer to this genuinely difficult balancing act. But the answer must relate to Read more