Delay cuts, says leading economists

Sixty-seven economists have today entered the debate over the pace of deficit reduction. Their letter is in response to a separate call in last weekend’s Sunday Times, where a group of 20 economists said “there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.”

The letters are reproduced below in full.

Letter 1:

From Lord Skidelsky and 57 others.

Sir, In their letter to The Sunday Times of February 14, Professor Tim Besley and 19 co-signatories called for an accelerated programme of fiscal consolidation. We believe they are wrong.

They argue that the UK entered the recession with a large structural deficit and that “as a result the UK’s deficit is now the largest in our peacetime history”. What they fail to point out is that the current deficit reflects the deepest and longest global recession since the war, with extraordinary public sector fiscal and financial support needed to prevent the UK economy falling off a cliff. They omit to say that the contraction in UK output since September 2008 has been more than 6 per cent, that unemployment has risen by almost 2 percentage points and that the economy is not yet on a secure recovery path.

There is no disagreement that fiscal consolidation will be necessary to put UK public finances back on a sustainable basis. But the timing of the measures should depend on the strength of the recovery. The Treasury has committed itself to more than halving the budget deficit by 2013-14, with most of the consolidation taking place when recovery is firmly established. In urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!

They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession? To ask – as they do – for independent appraisal of fiscal policy forecasts is sensible. But for the good of the British people – and for fiscal sustainability – the first priority must be to restore robust economic growth. The wealth of the nation lies in what its citizens can produce.

Letter 2:

From Prof Lord Layard and eight others.

Sir, Last Sunday 20 fellow economists wrote to The Sunday Times advocating a more rapid reduction of Britain’s budget deficit than is currently planned in the Pre-Budget Report. “There is a compelling case”, they said “for the first measures beginning to take effect in the 2010-11 fiscal year.”

We disagree.

First, while unemployment is still high, it would be dangerous to reduce the government’s contribution to aggregate demand beyond the cuts already planned for 2010-11 (which amount to 1 per cent of gross domestic product). Further immediate cuts – even supposing they are practicable – would not produce an offsetting increase in private sector aggregate demand, and could easily reduce it. History is littered with examples of premature withdrawal of the government stimulus, from the US in 1937 to Japan in 1997. With people’s livelihoods at stake, a responsible government should avoid reckless actions.

Second, Britain’s level of government debt is not out of control. The net debt relative to GDP is lower than the Group of Seven average, and on present government plans it will peak at 78 per cent of annual GDP in 2014-15, and then fall. Even at its peak, the debt ratio will be lower than in the majority of peacetime years since 1815. Moreover British debt has a longer maturity than most other countries, and current interest rates on government debt at 4 per cent are also low by recent standards.

Third, since the crisis began, private households and businesses have had to increase their saving in order to reduce their debts. It is this saving that finances the government deficit. If the government did not take up the slack, there would be a deeper recession. But fortunately, wise counsel has prevailed so far, and public spending has been maintained as an offset to reduced spending by the private sector.

Of course there needs to be a clear plan for reducing the government deficit. But the existing one for next year appears sensible. What is needed then is much more detail for the following years, and a radical plan for the medium term. That is what the debate should be about.

A sharp shock now would not remove the need for a sustained medium-term programme of deficit reduction. But it would be positively dangerous. If next year the government spent less and saved more than it currently plans, this would not “make a sustainable recovery more likely”. The weight of evidence points in the opposite direction.

UPDATE 9:45

This is how today’s FT editorial concludes:

“Friday’s letters are an embarrassment for the Tories, above all, who sought to capitalise on the first letter. They must learn – soon – that their desire for simple political messages is no excuse for nuance-free policy positions.”

UPDATE 1:15

38 Degrees have set up a petition calling urging the parties not to “risk the recovery” by “cutting public spending too soon”.

It says:

“Dear Alistair Darling and George Osborne,

“Please don’t jeopardise our recovery from recession by making premature cuts to public spending.

“Please listen to the economic experts and pledge to make jobs and financial stability your priority to avoid a disastrous “double-dip” recession.”

• Sign it here