Balance of risks
Contrary to the rhetoric around economic policy, the real disagreements have had little to do with ideology or economic theory. The government has happily deployed Keynesian techniques where feasible – as in its counter-cyclical fiscal policy. It has been sufficiently pragmatic to allow the fiscal consolidation to drift from four years to seven. The question throughout has been how to maintain the confidence of creditors when the government is having to borrow at historically exceptional levels, without killing confidence in the economy in so doing through too harsh an approach.
When the government was formed it was in the context of febrile markets and worries about sovereign risk, at that stage in Greece, but with the potential for contagion. There was good reason to worry that the UK, as the country arguably most damaged by the banking crisis and with the largest fiscal deficit in the G20, could lose the confidence of creditors without a credible plan for deficit reduction including an early demonstration of commitment.
Almost three years later, the question is whether the balance of risks has changed. The IMF argued last May that the risk of losing market confidence as a result of a more relaxed approach to fiscal policy – particularly the financing of more capital investment by borrowing – may have diminished relative to the risk of public finances deteriorating as a consequence of continued lack of growth.
On the balance of risks, there is no “right” or “wrong” answer. There is no theoretically correct solution: rather, a matter of judgment – which incorporates a political assessment of which risk is the least palatable. There is a body of opinion arguing that the risks to the economy of sticking to existing plans are greater than the risks stemming from significantly increased and sustained public investment targeted at those areas of the economy where there are severe impediments to growth (housing; skills; infrastructure; innovation). But this is also too crude and binary a characterisation of the position; the government has carried out considerable policy reform in these areas, not least in my own department, the fruits of which take a while to mature. The balance of risks remains a matter of judgment.
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