Wolf at the door for Cameron

David Cameron today used his first major speech since becoming Prime Minister to focus on the economy and attempt to make the case for immediate spending cuts. But his rationale is flawed, as the Financial Times’ Martin Wolf made clear this morning.

This afternoon, David Cameron said:

“Today, the British state is borrowing one pound for every four it spends.  Our Budget deficit is set to overtake Greece.  If we don’t deal with this, there will be no growth, there will be no recovery. It will be undercut by rising interest rates, rising inflation, falling confidence and the prospect of higher taxes.  Getting the deficit down and keeping it down will help to restrain inflationary pressures, allow interest rates to remain lower for longer and create the space for private sector investment.”

In this morning’s FT, Martin Wolf took umbrage with a similar argument from the OECD:

“Here are some facts, to keep the hysteria in check: the UK economy is operating at least 10 per cent below its pre-crisis trend; the OECD estimates the “output gap” – or excess capacity – at slightly over half of this lost output; the UK government is able to borrow at a real interest rate of below 1 per cent, as shown by yields on index-linked gilts; the yield on conventional 10-year gilts is 3.6 per cent; the ratio of gross debt to gross domestic product was 68 per cent at the end of last year, against 73 per cent in Germany and 77 per cent in France and an average of 87 per cent since 1855; the average maturity of UK debt is 13 years, according to the International Monetary Fund’s Fiscal Monitor; and, yes, core inflation has risen to 3.2 per cent, but that is hardly a surprise, given the large – and essential – sterling depreciation.

“Above all, the private sector is forecast by the OECD to run a surplus – an excess of income over spending – of 10 per cent of GDP this year. On a consolidated basis, the UK’s private surplus funds nearly 90 per cent of the fiscal deficit. Thus, fiscal tightening would only work if it coincided with a robust private recovery. Otherwise, it would drive the economy into deeper recession.”

This graph shows how the yield on conventional 10-year gilts which Martin Wolf refers to have fallen recently: