Recommended Reading: Stimulus and risk – why the Keynesian borrowers are wrong

Economic policy in Britain is in desperate need of a radical overhaul, however Labour’s Keynesian alternative of print, borrow and spend is not the answer. In this excellent article Dr Tim Morgan, Global Head of Research at Tullett Prebon, helps explain why the Keynesian prescription is actually an extremely dangerous and foolhardy option.

As Dr Morgan explains:

“There can be no denying the seductive attraction of a Keynesian (“borrow more to stimulate growth”) solution. Increased government borrowing, Keynesians argue, would boost the economy so, although it would increase deficits in the near-term, it would enhance tax revenues on a longer perspective, resulting in an eventual reduction in borrowing. Superficially, it’s a very persuasive argument but, if it sounds too good to be true, that’s because it is.”

He goes on to expose the flaws in the Keynesian remedy pointing out that government stimulus has already been tried on an unprecedented scale, and yet has clearly failed.

“Over the four fiscal years from 2009-10 to 2012-13, government borrowings have totalled £565bn at 2012-13 values, equivalent to 37% of GDP. If you add quantitative easing to this, the stimulus total rises to over 60% of GDP, or an average of 15% for each of the four years, The problem, then, is not that government hasn’t tried Keynesian stimulus, but that it has been tried by the bucket-load – and hasn’t worked.”

He also notes that one of the reasons that the dramatic increase in government debt has failed to deliver growth, is because we are not dealing with a typical “destocking recession (which can respond to stimulus)”, rather we are facing a “deleveraging recession (which can’t)”. As a result, “Any stimulus poured into the economy by the government is used by the private sector, not to increase demand, but to reduce its own indebtedness. Trying to cure a deleveraging recession with stimulus is like pushing on a string.”

Another important point Dr Morgan addresses, is the fact that Britain’s total debt, that is, “government, household and business debt together… is over 500% of GDP”, and that servicing this debt is a “critical issue”.

“Government debt interest payments are already set to rise from £47bn to £71bn over the coming five years, but each increment of just 1% in overall rates would add £12bn to this figure. Households with mortgages are even more exposed – though rates are now at rock bottom, one in eight mortgages is already in forbearance, and a 200bps rise could imperil as many as half of the remainder.”

In conclusion he emphasises the importance of addressing this issue:

“If you follow through on what an interest rate rise would mean, the increase in government borrowing costs would either drive the deficit upwards or other spending down. Higher rates would hit house prices hard, creating huge banking losses, and the slump in mortgage-payers’ disposable incomes would not only have a gravely damaging impact on GDP but could also create another wave of bank losses in commercial property. The government knows that balance sheets – its own, and the banks’ – are in no fit state to cope with anything remotely like this.”

Policymakers need to recognise (and then address), the fact that the wealth creation mechanism in Britain is severely impaired. What’s needed is a radical package of measures that unleash the productive private sector and make it much easier for people to save, invest, and create competitive businesses.

Read the full article here.

Dr Tim Morgan | Global Head of Research at Tullett Prebon.

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