J. Bradford DeLong
The Humiliation of Great Britain J. Bradford DeLong U.C. Berkeley October 23, 2010
The World Diverges At the end of 2008, as the financial crisis hit with its full typhoon force, the countries of the world divided into two: those countries where leaders decided to muddle through on the one hand, and China on the other-which took seriously Milton Friedman and John Maynard Keynes's strictures that the first thing to do is use the government to make strategic interventions in production and financial markets to maintain the flow of aggregate demand. Then at the start of 2010 those countries that had been muddling through again divided into two: those countries where government credit was unimpaired continued to muddle, while countries like Greece and Ireland where government credit was impaired found that they had no choice but to pursue austerity and try to restore confidence in government credit lest something worse than mere depression befall them. Now the countries are splitting in two again: those that are muddling through, and Great Britain, where even though government credit is still solid gold the new government is about to embark on what may be the largest sustained fiscal contraction ever: a plan to shrink the government budget deficit by 9% of GDP over the next four years.
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J. Bradford DeLong
So far China is doing the best in dealing with the financial crisis. The mudding-through countries lag behind. And those where confidence in the government's liabilities has cracked and the government is forced into austerity are doing worst.
The Question for Britain Now the question is: will Britain--where confidence in the government has not cracked and where austerity is not forced but chosen--join the others at the bottom and serve as a horrible warning. The Conservative Salad government used to claim that its policies will produce a boom by bringing a visit from the Confidence Fairy that would greatly reduce long-term interest rates and cause a huge surge of private investment spending. But they appear to have abandoned that claim. The claim is not that cutting will produce recovery. Rather, the claim is that failure to cut will produce disaster. As Osborne said on April 23: The immediate reductions to in-year spending have bought us a breathing space in the sovereign debt storm.... The emergency Budget in June was the moment when fiscal credibility was restored. Our market interest rates fell to near record lows. Our country's credit rating was affirmed. And the IMF went from issuing warnings to calling our Budget "essential". Now we must implement some of the key decisions required by that Budget. To back down now and abandon our plans would be the road to economic ruin...
Thus the claim now is that there is no alternative to mammoth cuts in government spending and increases in taxes. But if you ask supporters of the government why there is no alternative, they sound confused and
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J. Bradford DeLong
incoherent--or perhaps they are merely parroting talking points that they know have little thought behind them.
A Brief Dialogue "What will be so bad about continuing to run large budget deficits until the economic recovery is well established?" we ask. "Yes, the debt will be higher and interest on that debt will have to be paid, but the British government can borrow right now at extraordinarily favorable terms. When interest rates are low and you can borrow on favorable terms, those are the moments when the market wants you to pull government spending forward into the present and push taxes back into the future." They think for a little while. Then they say: "Confidence in the government's credit might collapse, and the government might have to rollover its debt at unfavorable terms--or might be unable to refinance it at all, and then would have to suddenly cut taxes and raise spending." "But," we say, "that is what you are doing now. How is the possibility that you might be forced to adopt your policies under duress an argument for adopting them right now, before the recovery is well established?" "It is worse," they say. "Back in the 1970s confidence in the credit of the British government collapsed, and we had to borrow from the IMF to create room so that spending could be cut and taxes raised gradually rather than in a sudden stop." "Well yes," we say. "That is what the IMF is for. An IMF program restores confidence in the soundness of the finances of the government that markets distrust. The lending allows the necessary medium- and long-term spending cuts and tax increases to be undertaken at a more appropriate time. That is what the IMF is for. That is why John Maynard Keynes and Harry Dexter White set it up--and they were not dumb." "But to borrow from the IMF is humiliating," they say.
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J. Bradford DeLong
"But businesses set up lines of credit for future contingencies all the time," we say, "and they don't think there is anything humiliating bout resorting to them when those contingencies come to pass." "But to have to borrow from the IMF is humiliating," they say. "Hmmm." We think for a while. "Suppose that there were a guaranteed non-humiliating way to borrow from somebody else--not the IMF," we might posit. "Would it not then make sense to do so? Would it not make sense to spread out the--necessary medium-term--spending cuts over eight years? Would it not then make sense to postpone the start of the spending cuts for a year or two until there is a much greater chance that the recovery is well-established? If somebody were willing to lend to Britain on the same terms that the IMF would do so--but in a non-humiliating way-wouldn't it be worth taking the loan and stretching out the period of adjustment in order to avoid hitting the economy on the head with a brick while it is so weak?" They might agree. But then they would say that there is no such alternative entity willing to lend to Britain.
Borrowing from Your Own People Is Not Humiliating But there is. As Chancellor Osborne said, right now the interest rates Britain pays to borrow are at near-record lows. The British people are willing to lend to their government on an enormous scale at terms that are more generous than the IMF offers. And if you are worried that the British people might change their minds--well, then, the princes of Wall Street or the barons of Canary Wharf or Tim Geithner would certainly be willing to sell derivatives contracts to guard Britain against exchange rate risk for the next several years. To borrow from your own people is not humiliating. It is especially not humiliating when your economy is in depression, when the interest rates
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you can borrow at are at near-record lows, and when every economic argument cries out for pulling spending forward from the future into the present and pushing taxes from the present back into the future. What is humiliating is to cut half a million government jobs and cause the loss of half a million private ones--a 3.5% increase in the unemployment rate in an economy of 30 million jobs--when there are no sources of expanding private-sector demand to pick up the slack. October 23, 2010: 1231 words
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