Given recent economic problems, what are the possible solutions?
For the UK and US, I really feel the economy could be helped if there was strong and decisive leadership. The fundamental thing is the government need to stop emphasizing the need for austerity and hard times. They are currently trying their best to talk us into a recession. It is not just a fiscal crisis, the real problem is the prospect of a second recession.
- Lack of Economic growth
- High Unemployment
- Long-term structural deficits
- Lack of Confidence in finance and consumer sector.
1. Number One priority to Target Economic growth and reduce unemployment. At the very least, economic growth needs to be close to long run trend rate 2.5%; it actually needs to be higher to catch up with lost spare capacity. Strong growth will help boost tax revenues and reduce unemployment. It is only in this climate you can successfully reduce the deficit.
There is supply-side unemployment, especially in Europe, which has seen prolonged structural unemployment in past two decades. But, the fundamental cause is lack of aggregate demand. (see: The Unemployment Problem)
The UK and US should make a point of not cutting spending in this current economic climate. Governments should be bold and say the best way to reduce Debt / GDP ratios – is to increase GDP and this is what we are going to do.
Governments have to stop focusing on the negative and the necessity for austerity and hard times. If they want to turn around consumer and business confidence, they should convince the country their aim is to boost growth and reduce unemployment. – This is the thing that will really encourage stock markets and bond markets.
UK National debt – grew significantly during First and Second World War – long period of economic growth enabled the economy to pay off debt.
Many countries are making the mistake of trying to solve long term structural deficits, by sacrificing short term growth. In the name of long term structural change, governments are deflating the economy at a time when they should be doing the opposite.
The UK and US should be setting out plans to reduce the long term deficit, but this should not be involving short term cuts in spending on important capital investment. These long term policies should involve:
- Raising retirement age in response to an ageing population.
- Evaluating automatic health care spending in the US.
- Seeking to move people off long term benefit (e.g. helping those on disability allowance find less taxing jobs)
- Planned Tax rises which are appropriate for incentives, efficiency and equality. e.g. US should be planning to raise tax on petrol, and tax on those high income earners who have befitted from recent tax cuts.
These kind of policies are sustainable and actually, make a big difference to long term budget situation. If you sell off assets or stop current capital investment projects, it is a very limited benefit to the long term budget. But, if you make changes to retirement age or entitlement spending this isn’t just a one off benefit, but a permanent improvement to the government’s fiscal position.
Bond yields in the UK and US are near record lows. If the government came up with plans to improve long term budget situation over next 20 years, markets would be willing to lend for short-term economic recovery.
Higher debt leads to lower bond yields (lower borrowing costs)