On Bloomberg.com former MPC member David Blanchflower argues that the 'Conservative austerity idea is failing'. The former external member of the Bank of England’s Monetary and Policy Committee (MPC) suggests that the coalition government is driving the economy into another recession. Yet despite the confidence with which he asserts his prediction, Mr Blanchflower does not have a crystal ball. Of course, we might indeed experience two successive quarters of negative growth, but likely not for the reason put forward in this article.
Despite his academic credentials, Mr Blanchflower is a political beast – and his analysis reads as such. His thesis is built upon his belief that tax cuts – or even the thought of tax cuts – will cause a double-dip. But Keynesian obfuscation on the animal spirits doesn’t really get us anywhere. As much as the coalition government’s rhetoric and policy proposals of tax rises and cuts might be worrying consumers and businesses, the previous government’s head-in-the-sand deficit denial was also causing uneasiness. Let’s not forget that the hawks were circling around UK government debt. When politicians have brought your country to the point of bankruptcy and central bankers are ignoring the inflation eating away at your wealth, lacking confidence is a pretty natural reaction.
So rather than coming in on the side of whether the disease or the medicine leads to the greater loss of confidence, better to focus on what works. Luckily, Alberto Alesina and Silvia Ardagna of Harvard University have done the hard work. In a 2009 paper entitled ‘Large changes in fiscal policy: taxes versus spending’ they conclude that:
Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.
The paper is worth reading in full as it is comprehensive in scope, has a simple and convincing methodology, and comes to the unequivocal conclusion that tax cuts trump spending. Confidence is a tricky policy lever to pull, one based on facts tends to be much more successful.