My position is this:




Good article here....

blogs.telegraph.co.uk/news/iainm ... -disaster/

"But going into the crash the government was spending too much. Spending had risen dramatically from 2001 and the government was recklessly running deficits at the top of a boom. That doesn't mean that increased government spending caused the crash. Of course not. Instead, what should be obvious, is that it left the country poorly prepared for a downturn when it turned up.


"If spending had been at more sensible levels before the crash, the fall off in revenues would not have had such a dramatic impact and the deficit would have been smaller, meaning that the amount being added to the national debt would have been less than it turned out to be from 2008. If government spending had been considerably lower in the boom years, both the deficit and the debt could have been lower than they are now in the bust"

My position is this:




Good article here....

blogs.telegraph.co.uk/news/iainm ... -disaster/

"But going into the crash the government was spending too much. Spending had risen dramatically from 2001 and the government was recklessly running deficits at the top of a boom. That doesn't mean that increased government spending caused the crash. Of course not. Instead, what should be obvious, is that it left the country poorly prepared for a downturn when it turned up.


"If spending had been at more sensible levels before the crash, the fall off in revenues would not have had such a dramatic impact and the deficit would have been smaller, meaning that the amount being added to the national debt would have been less than it turned out to be from 2008. If government spending had been considerably lower in the boom years, both the deficit and the debt could have been lower than they are now in the bust"

Ajw71 is just backtracking now to try and say he was right in what he claimed by clinging to four 'facts' which are relatively meaningless. Two of them are just quotes that Labour ministers said, they are not measures of economic performance. The other two appear to be the same 'fact': ie there was no recession from 2002 to 2007 but there was no surplus.

There was no recession from 1992 to 1997 either and there was no surplus. Fact. Growth rates were bigger from 1992 to 1997 and deficits were also bigger. Fact. On the grounds Ajw is arguing, John Major's Conservative government comes out much worse.

In practice governments very rarely run surpluses, John Major's government never ran one, neither did Gordon Brown's. Margaret Thatcher's ran two years of surplus in eleven, and Tony Blair's ran four years of surplus in ten which is probably the best record ever for a British PM.

The reason why surpluses are not usually run is that unless you have no investment projects that can be run, they are not the best use of funds, because you can generate better longer term returns through borrowing to invest. Like any business, if the government can borrow at a rate of 1% and uses this to fund a project with returns at 2% then that's a profitable decision.

The argument about 'saddling future generations with the bill' is misleading because you have to take into consideration the higher returns that yield from the projects government invests in now. Most things government invests in, education, health, transport infrastructure etc create a more skilled and mobile workforce that will generate economic growth in the future hence higher tax revenues. As long as the returns are higher than the rate of interest the government is borrowing at then the future generations are in profit after the bill has been paid back. Add to this the fact that the majority of UK government debt is held within the UK so when the government pays it back this goes back into the domestic private sector and recycles around the economy: when it pays to foreign debt holders that money leaks out of the system but the repayments that go to UK debt holders end up getting spent (and coming back to government through taxes) in the UK.

Where deficits become a problem is when the government's ability to pay its debts comes into question hence nobody will lend to it any more. If you have a deficit between outgoing spending and incoming tax revenues and need to cover that through borrowing and nobody will lend then you run into a cash flow problem and this is where you have to turn to the IMF as lender of last resort. The IMF will usually provide the money but on their terms so you lose control of your own budget then.

This issue is called fiscal sustainability and the best guide to sustainability is to look at the figure of debt stock as a proportion of GDP. If it is rising year after year then you have an unsustainable situation because at some point it is going to become so large lenders will start worrying that the government can cover it and hence demand higher rates of interest to lend to them, which in turn makes it harder to meet the repayments and so a debt spiral starts. Greece is in this situation now. If the debt stock to GDP is constant or falling then you are on a sustainable path.

There's a well known rough and ready formula for fiscal sustainability which is

(T2 - G2)/GDP2 = (r-g) (B1/GDP1)

the number after the letter refers to the year (ie 1 for Year 1 - this year, 2 for Year 2 - next year)
T stands for taxation, G stands for government spending, r stands for rate of interest on government debt, g stands for growth rate of GDP

The left hand side is called the primary surplus which is the surplus of tax minus spending before you take into account interest payments on previous debt stock. If the left hand side equals the right hand side you are on a sustainable path. If the left hand side is smaller than the right hand side then your debt stock will grow relative to GDP and in the long run this is unsustainable. If the left hand side is bigger then your debt stock will shrink relative to GDP and this is the best position to be in.

The key conclusion to draw from this is that when r-g is negative, ie the annual growth rate exceeds the rate of interest on government debt, then you can run a primary deficit and still be sustainable. A government which generates returns on its borrowing that exceed the rate of interest on its borrowing can run a deficit forever and never run into debt problems.

Back to the Treasury pocket databank www.hm-treasury.gov.uk/d/pdb.pdf and p14 and look at the fourth column on the second half of the page, net public sector debt (HF6X). This is the stock of debt as a proportion of GDP - what the country owes as a proportion of its income. As you will see this was quite low at the start of the 1990s, 27.1%. This rose steadily during Major's government to 42.4% by 1997, as a result of those large deficits Major's government was running. Despite strong growth rates our deficits were large enough that we were on an unsustainable path.

From 1997 to 2002 we were on a healthy and sustainable path, the debt ratio had been reduced to 29.7% and then it started to rise again and was 35.9% by 2007. This was not in the long term a sustainable situation but not one to raise the alarm bells, and it was still considerably lower than the debt ratio left at the end of the Conservative government in 1997.

Then as a result of the financial crisis and collapse in GDP that shot rapidly from 36.7% in 2008, to 43.5% in 2009, to 52.5% in 2010. This is where the Coaltion took over. The attack from the Conservatives that Labour "wrecked the country's finances" is based on the acceleration in debt ratio in these past two years.

Since then we have gone to 60.5% in 2011 and 66.0% in 2012, so the acceleration in unsustainabilty has increased at a similar rate. So if we take the crude argument that the incumbent government is entirely responsible for the state of the public finances then the Coalition has ruined the public finances in the past two years as much as Labour did in the previous two.

As well as having the Fiscal Mandate that I talked about in an earlier post where the Chancellor promised to have a budget balance on current budget (ignoring investment spending) by 2015, there is a Supplementary Target which is that the debt ratio should be declining before 2015, ie we should be back on a sustainable path. The Office for Budget Responsibility are going to release their next estimate in December about whether he is on target for that and its expected they will say he will miss it.

There has been a recent and influential paper on the effect of growth and debt ratios (by Reinhart and Rogoff) that comes up with 90% as the real key tipping point. At ratios below 90% debt ratios don't seem to have major adverse effects but once you pass 90% the burden starts to have negative effects on economic performance and restrains growth in the long run.

Ajw71 is just backtracking now to try and say he was right in what he claimed by clinging to four 'facts' which are relatively meaningless. Two of them are just quotes that Labour ministers said, they are not measures of economic performance. The other two appear to be the same 'fact': ie there was no recession from 2002 to 2007 but there was no surplus.

There was no recession from 1992 to 1997 either and there was no surplus. Fact. Growth rates were bigger from 1992 to 1997 and deficits were also bigger. Fact. On the grounds Ajw is arguing, John Major's Conservative government comes out much worse.

In practice governments very rarely run surpluses, John Major's government never ran one, neither did Gordon Brown's. Margaret Thatcher's ran two years of surplus in eleven, and Tony Blair's ran four years of surplus in ten which is probably the best record ever for a British PM.

The reason why surpluses are not usually run is that unless you have no investment projects that can be run, they are not the best use of funds, because you can generate better longer term returns through borrowing to invest. Like any business, if the government can borrow at a rate of 1% and uses this to fund a project with returns at 2% then that's a profitable decision.

The argument about 'saddling future generations with the bill' is misleading because you have to take into consideration the higher returns that yield from the projects government invests in now. Most things government invests in, education, health, transport infrastructure etc create a more skilled and mobile workforce that will generate economic growth in the future hence higher tax revenues. As long as the returns are higher than the rate of interest the government is borrowing at then the future generations are in profit after the bill has been paid back. Add to this the fact that the majority of UK government debt is held within the UK so when the government pays it back this goes back into the domestic private sector and recycles around the economy: when it pays to foreign debt holders that money leaks out of the system but the repayments that go to UK debt holders end up getting spent (and coming back to government through taxes) in the UK.

Where deficits become a problem is when the government's ability to pay its debts comes into question hence nobody will lend to it any more. If you have a deficit between outgoing spending and incoming tax revenues and need to cover that through borrowing and nobody will lend then you run into a cash flow problem and this is where you have to turn to the IMF as lender of last resort. The IMF will usually provide the money but on their terms so you lose control of your own budget then.

This issue is called fiscal sustainability and the best guide to sustainability is to look at the figure of debt stock as a proportion of GDP. If it is rising year after year then you have an unsustainable situation because at some point it is going to become so large lenders will start worrying that the government can cover it and hence demand higher rates of interest to lend to them, which in turn makes it harder to meet the repayments and so a debt spiral starts. Greece is in this situation now. If the debt stock to GDP is constant or falling then you are on a sustainable path.

There's a well known rough and ready formula for fiscal sustainability which is

(T2 - G2)/GDP2 = (r-g) (B1/GDP1)

the number after the letter refers to the year (ie 1 for Year 1 - this year, 2 for Year 2 - next year)
T stands for taxation, G stands for government spending, r stands for rate of interest on government debt, g stands for growth rate of GDP

The left hand side is called the primary surplus which is the surplus of tax minus spending before you take into account interest payments on previous debt stock. If the left hand side equals the right hand side you are on a sustainable path. If the left hand side is smaller than the right hand side then your debt stock will grow relative to GDP and in the long run this is unsustainable. If the left hand side is bigger then your debt stock will shrink relative to GDP and this is the best position to be in.

The key conclusion to draw from this is that when r-g is negative, ie the annual growth rate exceeds the rate of interest on government debt, then you can run a primary deficit and still be sustainable. A government which generates returns on its borrowing that exceed the rate of interest on its borrowing can run a deficit forever and never run into debt problems.

Back to the Treasury pocket databank www.hm-treasury.gov.uk/d/pdb.pdf and p14 and look at the fourth column on the second half of the page, net public sector debt (HF6X). This is the stock of debt as a proportion of GDP - what the country owes as a proportion of its income. As you will see this was quite low at the start of the 1990s, 27.1%. This rose steadily during Major's government to 42.4% by 1997, as a result of those large deficits Major's government was running. Despite strong growth rates our deficits were large enough that we were on an unsustainable path.

From 1997 to 2002 we were on a healthy and sustainable path, the debt ratio had been reduced to 29.7% and then it started to rise again and was 35.9% by 2007. This was not in the long term a sustainable situation but not one to raise the alarm bells, and it was still considerably lower than the debt ratio left at the end of the Conservative government in 1997.

Then as a result of the financial crisis and collapse in GDP that shot rapidly from 36.7% in 2008, to 43.5% in 2009, to 52.5% in 2010. This is where the Coaltion took over. The attack from the Conservatives that Labour "wrecked the country's finances" is based on the acceleration in debt ratio in these past two years.

Since then we have gone to 60.5% in 2011 and 66.0% in 2012, so the acceleration in unsustainabilty has increased at a similar rate. So if we take the crude argument that the incumbent government is entirely responsible for the state of the public finances then the Coalition has ruined the public finances in the past two years as much as Labour did in the previous two.

As well as having the Fiscal Mandate that I talked about in an earlier post where the Chancellor promised to have a budget balance on current budget (ignoring investment spending) by 2015, there is a Supplementary Target which is that the debt ratio should be declining before 2015, ie we should be back on a sustainable path. The Office for Budget Responsibility are going to release their next estimate in December about whether he is on target for that and its expected they will say he will miss it.

There has been a recent and influential paper on the effect of growth and debt ratios (by Reinhart and Rogoff) that comes up with 90% as the real key tipping point. At ratios below 90% debt ratios don't seem to have major adverse effects but once you pass 90% the burden starts to have negative effects on economic performance and restrains growth in the long run.