Leading article: The argument of the fiscal doves is more compelling

Britain's economy is too weak to bear deep and immediate cuts
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The Independent Online

According to George Bernard Shaw, "if all economists were laid end to end, they would not reach a conclusion". But today's problem, as far as the world is concerned, is not the profession's equivocation, but the fact that economists seem to be reaching rather different conclusions.

Last weekend, 20 distinguished economists wrote to The Sunday Times calling for the next government to begin cutting the budget deficit in the 2010/11 financial year. But yesterday there was a counterblast from 60 equally distinguished practitioners of the dismal science in letters to the Financial Times, arguing that cuts should not take place until the economy is able to bear it.

Because the Conservatives, until relatively recently, have been pressing the need to deal with the deficit urgently, while the Government has been more cautious, the spat has gained a partisan edge. But which side is right? The fiscal hawks, who want to slash the deficit now, or the fiscal doves, who say hold off?

First it is important to acknowledge what both sides agree on: that the deficit needs to come down in time. They all share the view Britain cannot continue borrowing 12 per cent of its annual GDP output indefinitely. What they disagree on is the timing of the necessary fiscal consolidation.

There is not necessarily a right or wrong answer when it comes to timing. It is a question of judgement. And the judgement of the doves seems better grounded in reality. The hawks argue that there is a risk of international investors dumping British debt if the deficit gets out of hand, which would force up interest rates, hurt borrowers and damage the economy. But this argument is overdone. The yield, or interest rate, on medium- and long-term British gilt-edged securities is not particularly high by historical standards, suggesting that there is no imminent panic from foreign investors. And demand for gilts is still robust, despite the end of quantitative easing, not least because British households and companies are furiously paying off debt, which increases domestic demand for government bonds. Public-sector borrowing is being, to some extent at least, counteracted by private-sector saving.

Yet while the risks of maintaining the deficit are exaggerated, the risks of slamming on the fiscal brakes too early are very real. The real economy remains extremely weak, growing by just 0.1 per cent in the fourth quarter of 2009. Without the Government's VAT cut last year and the car scrappage scheme, Britain might well have still been in recession. If the Government were to begin withdrawing demand from the economy by slashing current spending, on top of the tightening that is already taking place this year with the return of VAT to 17.5 per cent, the economy could easily slump again. And with a contracting economy, the ratio of the deficit to GDP would grow. Fiscal consolidation, before the private sector is sufficiently healthy to take up the slack in the economy, would be self-defeating.

As for the politics of this, though the Government drew some comfort from the vindication of some experts yesterday on the timing of cuts, ministers are still to set out how they would meet their own deficit reduction targets in the medium term. With the softening of the Conservative line on the timing and scale of cuts last month, this – the question of where the axe will fall – is the great blank space at the heart of British politics. And it is this space that needs to be filled if the hawks' prophecies of a collapse in market confidence in the ability of the British state to sort out its deficit are to be avoided.