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“Even worse than we thought.”

This was David Cameron’s take on the UK’s economic situation over the weekend. He said that painful cuts would have to be made which would affect “our whole way of life”.

He also added that: “Because the legacy we have been left is so bad, the measures to deal with it will be unavoidably tough …”

His argument was that unless the deficit was tackled immediately there would be a drop in confidence in the UK economy which would result in interest rates going up, which in turn would increase borrowing costs.

I am getting increasingly worried about the scale of the hysteria concerning government borrowing and the softening up of the UK public to expect severe and prolonged cuts. With Germany announcing its own austerity programme this weekend and international organisations such as the OECD and IMF stipulating the need for cutbacks, we could well see a downward spiral in spending, production and growth. I could see the UK slipping back into recession over the next twelve months.

It is important to point out that there is no general agreement on the need for such swingeing cuts at the moment. Yes, the public finances need to be put on a firmer footing. Yes, we need to trim waste and use government revenue more effectively. But, do we need to cut so quickly and so deeply?

Paul Krugman wrote an article in The New York Times today headed “Madmen in Authority”, in which he slated the demands for fiscal austerity. He maintained that the key thing to realise is that eliminating stimulus spending, while it would inflict severe economic harm, would do almost nothing to reduce future debt problems. Cutting the stimulus would result in lower revenue.

His argument is that the main reason that demands are being made for immediate fiscal austerity is to “reassure the markets” which is the reason that David Cameron has given. Krugman says that “….the markets supposedly won’t believe in the willingness of governments to engage in long-run fiscal reform unless they inflict pointless pain right now.”  However, he says that “…there is actually no sign that markets are demanding any such thing” with countries such as the US and UK being able to borrow at very low interest rates.

He concludes by saying: “So wise policy, as defined by the G20 and like-minded others, consists of destroying economic recovery in order to satisfy hypothetical irrational demands from the markets – demands that economies suffer pointless pain to show their determination, demands that markets aren’t actually making, but which serious people, in their wisdom, believe that the markets will make one of these days.”

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Posted in economic growth, Fiscal stimulus, government borrowing, government spending, Gross National Income, Interest rates

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