Myths of Fiscal Policy

“Don’t Panic, Captain Mainwaring.”

– Dad’s Army

The famous catchphrase could perhaps be adapted to UK debt levels. The 1940s and 1950s, were an example of high debt, but, it didn’t cripple the UK economy, the 1950s proved to be a decade of full employment and was one of the longest periods of economic expansion on record.

Debt creates a knee jerk reaction. Debt must be bad. e.t.c, but. In this post Jeremy Warner criticises Paul Krugman, he states

“The big point missed by those who think elevated public debt doesn’t matter is that these periods of excessive debt utterly crippled the UK economy.” –

It is true the Napoleonic war was very bad for the UK economy. But, the record debt levels of the 1950s (over 230% of GDP in 1951 Historical debt) can hardly be said to have crippled the economy. If full employment, low inflation, low interest rates and a decade of economic expansion is a definition of crippled economy, I still think we’d be happy to take that for 2010-2020.

Of course, there are many times, when chancellors panic. Like 1931, the UK worried about debt and so cut unemployment benefits to ‘balance the budget’. This just contributed to continued decline in Aggregate Demand and the mass unemployment of 1930s. The 1930s is a good example of how spending cuts can aggravate recessions and (fail to improve budget positions, you can also see modern day examples in Ireland)

There are quite a few misunderstandings about Keynesian fiscal policy, two of them include:

  1. Successful fiscal expansion relies on having a war and large military spending. No, fiscal expansion would work much better if it is targeted on public services under provided in a free market, such as: transport, health and education. These maintain AD and improve (rather than destroy) infrastructure.
  2. Fiscal Policy means bigger government. In a boom, governments should be aiming to run budget surplus (or at least very low borrowing). For example, restraining public spending, and not slashing taxes. From a fiscal point of view, in the boom years, it was a mistake to allow UK government spending to grow faster than GDP; in the US it was a mistake to cut income taxes in the boom. The government should have had better finances at the start of 2007, but, we didn’t and you have to deal with what you have.

Timing is crucial and there is an alternative to the governments fear inducing austerity drive. see: Alternatives to spending cuts

Myths of Great Depression

Fiscal Policy

By on October 25th, 2010

3 thoughts on “Myths of Fiscal Policy

  1. You say “There are quite a few misunderstandings about Keynesian fiscal policy.” My response is “too right”. The particular misunderstanding that concerns me at the moment is whether Keynes advocated extra spending in a recession funded by borrowing or funded by new money (i.e. “money printing”).

    The most authoritative figures on Keynes seem to veer towards the view that he advocated the money printing option, particularly towards the end of his life.

  2. I believe that whether it is a boom or not. the government should never aim for a surplus. Government spending especially on infrastructure, education and R&D should never stop. The reason for this is that in the long runit will ensure better means of production hence increasing output. It should only focus at gearing towards full employment and keeping inflation at a reasonable rate.

  3. A small amount of debt is good for an economy as it gives an economy a realistic objective. The profit motive is undermined in an economy that is mixed, and because Keynesianism calls for the regulation of aggregate demand, it leads to a mixed economy.

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