I wrote an article in this months (April) edition of Economic Review on the theme of spending cuts. It offers detailed arguments for spending cuts and also the problems of cutting spending in the current economic climate. It was written back in September quite a few months ago. A brief summary of the article.
Arguments in Favour of Cutting Spending
- Large deficit 12% of GDP gives the case for cutting spending to reduce the deficit.
- Problems in Eurozone means markets may be more reluctant to lend and more suspicious of government borrowing
- The size of the deficit suggests it is not just a cyclical deficit but also structural. With an ageing population and growing pension commitments, it needs action now to control future borrowing.
- Continued high levels of borrowing could lead to future crowding out and higher interest rates.
- Monetary policy is very loose to compensate for the tightening of fiscal policy.
Arguments Against cutting spending.
- Cutting spending with a weak economy could push us back into recession. This would make the cyclical deficit worse due to lower tax revenues. It is better to avoid cutting spending at this time and concentrate on long term strategy to reduce structural deficit when the economy is more resilient.
- Cutting spending is reducing consumer confidence and morale to record levels. Consumer spending is very weak and unemployment high.
- Cutting spending can be counter – productive. Countries with very strict austerity policies (Greece and Iceland) have not reassured markets. This is because cutting spending leads to much lower growth and debt to GDP ratios start to grow.
- Arguably we are still in a liquidity trap (low interest rates). In this situation government borrowing is not pushing up interest rates because there is reasonably strong demand for purchasing bonds.
- The UK situation is different to Ireland and Greece. We don’t have debt maturing so quickly. Outside the Euro, we have more flexibility such as devaluing exchange rate and pursuing expansionary monetary policy.
By the way, Economic Review is a very good magazine for A Level students. I remember reading it 14 years ago when doing my A Levels. It gives you good background reading and contemporary economic news pieces. Especially useful if you never get round to shifting through the Economist and Financial Times to find suitable articles.
Related
- Spending cuts and the economy
- Global economic austerity
- Economic Review at Phillip Allan
The recession was sparked off largely by excessive investment in both commercial and domestic property. And how do we combat the recession? We reduce interest rates to near zero, as mentioned above, presumably so as to encourage investment. That’s what I call a stroke of genius.