Car Crash Economics

Someone asked me recently what I thought of the ConDem government’s management of the economy.  My response?  Like a car crash, only rather more horrific.  Allow me to explain…

Back in 2007/8, the UK economy nose-dived.  The uncontroversial cause was the bursting of a credit bubble, which left the private sector with huge debt relative to its wealth.  In response, the sector attempted to restructure its collective balance sheet by restricting its lending to only the most gold-plated of borrowers, while saving, Scrooge McDuck-like, to pay down debt and insulate against future economic uncertainty (for more on this “balance sheet recession” phenomenon, see Koo).  This sucked demand out of the economy and led to economic contraction, unemployment, and general misery for a great many.

In these circumstances, the government had one economically viable option:  deficit-spend (i.e. spend in excess of tax receipts) to restore demand, inject confidence back into the economy, and get the private sector hiring again.  Instead, however, under the entirely spurious pretext that to deficit-spend would lead to ever higher interest rates and eventual national bankruptcy, the ConDems implemented a series of massive cuts to public spending that, utterly predictably, sucked further demand out of the economy, and led us, majestically, into double-dip recession.

To be clear: there remains but one route out of this economic car crash, and that is for the government to DEFICIT-SPEND, for a sustained period, probably years (yes, YEARS).

Contrary to ConDem spin, prolonged deficit-spending is perfectly feasible for a monetary sovereign like the UK.  Monetary sovereigns are governments that issue their own floating currencies, meaning they can spend whenever they wish and, by definition, cannot EVER bankrupt themselves.  Monetary sovereigns also have full control over interest rates, and need not EVER be forced into higher rates by markets.  On the contrary, markets lap up bonds issued by monetary sovereigns, since they are risk-free, interest-bearing assets.  This is borne out in practice, but is particularly noticeable in Japan, where the government has continually sold its bonds at low interest despite running deficits for the best part of 20 years. 

Inevitably, when all other arguments fail, the cry of INFLATION! goes up in response to calls for deficit-spending.  However, this simply illustrates a complete lack of understanding of how/why inflation occurs.  In short, as long as the spending (however financed) creates additional productive capacity, there won’t be any (demand-pull) inflation.  This leaves monetary sovereigns free to put the unemployed to work doing any number of socially useful things, such as building new energy-efficient homes, insulating existing homes, or providing better care for the elderly.

The maths is clear: the longer the ConDems are allowed to govern, the bigger the economic car crash they will create.

Let’s all make sure these clowns are voted out at the next election.

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