The persistence of fiscal stupidity

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BY CHRIS DILLOW | MARCH 24, 2018

Stupidity lives. This is the message of yesterday’s Spring Statement. Philip Hammond said:

If, in the Autumn, the public finances continue to reflect the improvements that today’s report hints at then, in accordance with our balanced approach, and using the flexibility provided by the fiscal rules I would have capacity to enable further increases in public spending and investment in the years ahead.

You shouldn’t need me to tell you this is daft. Government spending should not be constrained by the state of the public finances.

You don’t need to believe in MMT to see this. Bog-standard orthodox economics tells us the same. For one thing, when real interest rates are negative – as they have been since 2011 – governments can borrow a lot and still see its debt-GDP ratio fall over time. And for another, when interest rates are at rock-bottom, governments should relax fiscal policy to raise interest rates to give the Bank of England room for conventional monetary policy to work when the next slowdown hits.

Instead, the constraint upon government spending is inflation. If the government employs enough people, or raises their wages or spends enough on goods such as building materials, wages and prices will rise and that will push up interest and squeeze private spending.

It’s in this context that delaying public spending increases until the public finances improve is counter-productive. The best time to spend is when the public finances are poor because that is when the economy is depressed and inflation therefore not a problem. If you wait until government borrowing falls, you are more likely to increase spending when the economy is doing well and when capacity constraints are emerging. That’s when public spending is potentially inflationary.

Now, it’s unclear whether this is an argument against higher public spending soon. It might be that the very idea of aggregate spare capacity is mistaken, or perhaps capacity constraints (especially in a small open economy) don’t lead to much additional inflation. And there might well be a case for shifting the policy mix towards looser fiscal and tighter monetary policy. 

What is very clear, though, is that the case for increases in public spending was greater a few years ago than it will be next year, unless we get a major surprise.

If the fiscal stance is determined by the state of the public finances, we’ll get exactly the wrong policy – too much tightness when the economy is slack, and too much looseness in a boom.

Government finances are not like household finances, simply because public spending is so big that it affects the rest of the economy – something which is not true of households.

This, of course, should be known by any first-year student. Hammond, however, went out of his way to explicitly state his error:

That is how responsible people Budget. First you work out what you can afford. Then you decide what your priorities are. And then you allocate between them.

That may be true for a household. But it’s plain false for a sensible government.

My story here, though, is not about economics: all this should be too obvious to need saying.

Instead, it’s about politics. The persistence of the household fallacy shows that wrong ideas are not driven out of public life and debate doesn’t raise the quality of policy. Quite the opposite. As long as they hurt the poor whilst cosseting the rich, governments can get away with anything.


Chris Dillow is a UK based Marxist economist and writer at the Investors Chronicle. He blogs at Stumbling and Mumbling and is the author of New Labour and The End of Politics. Follow him on Twitter: @CJFDillow


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