One of the world's leading economists has urged Gordon Brown to reject "fiscal fetishism", defy the markets and maintain, or even extend, the fiscal stimulus of the British economy.
Joseph Stiglitz, who won the Nobel Prize for Economics in 2001 and has served as chief economic adviser to President Clinton and chief economist at the World Bank, warned that the financial markets were like a "crazy man" that could not be appeased with cuts to public spending.
"You're dealing with a crazy man. You're asking what I can do to placate a crazy man? Having got what he wants he will still kill you," he said.
In an exclusive interview with The Independent, Mr Stiglitz rejected the idea, put forward by David Cameron, that some symbolic trimming of the budget deficit in the current year might regain the confidence of the financial markets. He also said that it was "unconscionable" for the ratings agencies to threaten to downgrade Britain's creditworthiness, given their poor record in the crisis. "Fiscal fetishism is really dangerous," he said.
If the financial markets refused to buy British government bonds, or gilts, as Mr Cameron has suggested they soon might, the Bank of England could buy them instead, Mr Stiglitz said, as it did during its recently paused programme of quantitative easing, which mopped up about £200bn of gilts.
His intervention adds to the growing criticism of Mr Cameron's economic policy and will be seized on by Gordon Brown as evidence that Labour's policies are being backed by the world's leading economists.
Mr Stiglitz said that Mr Brown should make plans for how he might administer a further boost to the economy, in case the economic recovery proved to be even slower. "The likelihood is of a marked slowdown from current growth, which is very weak," he said. "Whether that means negative territory or stagnation will depend on what the Government does. If there is a premature withdrawal of stimulus it is more likely that there will be a 'double dip'."
He added: "You want to show a sensitivity towards the deficit but also sensitivity towards the timing [of a withdrawal of stimulus], and the fact is that recovery is not robust."
Mr Stiglitz said that European governments should offer the Greeks and other economies currently "under attack" much more support, to help restore confidence in their efforts to restore stability and help prevent the financial crisis spreading.
Mr Cameron has argued that comparatively small, but immediate reductions in public spending and the budget deficit, perhaps as small as £1bn out of a total deficit of around £175bn, could persuade the markets that an incoming Conservative government was getting the public finances under control. Mr Stiglitz however, stressed the continuing threats to recovery. The UK has emerged more slowly and more feebly than any other advanced economy from recession, and must be presumed to be the nation most at risk of a relapse into recession.
Mr Stiglitz, who dined with the Prime Minister and the Chancellor yesterday evening, said that the current Obama plan to break up the banks and restrict their ability to undertake proprietary trading – that is, trading on their own accounts – "doesn't go far enough". He criticised the US President for "muddling through" his response to the financial crisis, but said he was encouraged by the most recent developments in reforming regulation. However Mr Obama wants to extend the scope of US financial regulation both in the US and abroad to encompass the types of securities that are traded. Some especially complicated securities – which the boards of the banks that issued them famously couldn't understand – were held to be partly at fault for spreading and escalating the scale of losses seen during the credit crunch.
The boost to the US economy from President Obama's near $800bn package of tax breaks and public spending plans was also criticised by Mr Stiglitz for taking insufficient account of the decline in spending by individual states, which he argues has negated much of the federal initiative.
The British Government, which has rejected the Obama plan, was nonetheless warmly praised by Mr Stiglitz for its record: "What Brown has done in terms of banks so far is far better than what the US did; he demanded better compensation for providing money, better accountability, better attempts to restart lending, than in the US."