The scale of the budget deficit arises largely from the recession, which reflects the reluctance of the private sector to spend on goods and services. If the Government sought to reduce the deficit by raising taxes or reducing expenditure, the effect would be to deepen the recession. Such a policy should therefore be ruled out.
The Government's reaction should be to pursue a more imaginative policy in relation to modes of financing. We may start from the truism that if the public sector is to be in large financial deficit, the other sectors together must necessarily be in equivalent financial surplus. The non-bank private sector can be broken into (1) households; (2) insurance companies and pension funds; (3) industrial and commercial companies; and (4) the rest of the world.
The authorities should be prepared to improve the range of instruments available to the members of these sectors so that they will find acceptable means of placing that part of their financial surplus which they do not wish to invest in conventional gilt-edged stock. Thus the range and attractiveness of National Savings instruments could be extended. Foreign currency bonds could be offered to the overseas investor.
If there is a residual financing need, this will correspond to a decision by the private sector (taken collectively) to devote a corresponding part of its financial surplus to increasing its bank and building society deposits, rather than its holding of government instruments. The Government could and should in this case draw on these deposits indirectly through the intermediation of the banks and building societies. The latter will absorb Treasury Bills and/or short bonds to the extent necessary; they will lose nothing by doing so and will gain valuable income at a time when the scope for safe and profitable lending to private borrowers is being kept low by the recession.
This suggestion may alarm those who want to 'fully fund' the deficit by drawing on money outside the banking system. Government borrowing from banks and building societies is supposed to be bad because it increases the quantity of money and this is 'inflationary'. But how - in the circumstances we are contemplating - would it be inflationary? No one is forecasting that the budgetary policy which generates the deficit is going to produce a state of excess demand in the economy; the very idea is laughable.
No one - or hardly anyone - would object if, on the modest scale here envisaged, there was a resurgence in 1993/4 of private sector borrowing from the banks and building societies for spending on housing, consumption or investment. Indeed, it would be welcomed. Compare the two situations and suppose that the impact on real spending was the same in both. Then everything important would evolve on broadly similar paths - production, employment, the balance of payments, inflation and the quantity of money.
The only way in which the two cases would differ would be in respect of the final shape of the assets side of the balance sheets of the banks and building societies. In one case they would carry more liabilities of the government and in the other more liabilities of the private sector. How can it reasonably be said that the one case is bad and the other good when the difference between them is so minor?
We conclude that the full fund principle is inappropriate in the present condition of the economy.
The Reform Club
15 FebruaryReuse content