Hamish McRae ("Markets think Labour may revert to type", Business, 5 May) makes some interesting points about Labour and the budget deficit, but his comparision between Labour's plans to keep the national debt at a constant proportion of GDP and the experience of the 1970s (when Labour ran a budget deficit of 6.9 per cent) is too simplistic.

A constant debt-to-GDP ratio does not imply that the "deficit"- to-GDP ratio must be kept at the growth rate of the economy. The required size of the deficit depends on the size of the debt ratio, and, crucially, on the level of inflation. GDP is real (measured in "constant" prices), but the debt is in money terms; if inflation is 10 per cent, a 10 per cent addition to nominal debt leaves the real value at the end of the year unchanged.

So the high inflation of the 1970s meant that a large deficit was consistent with the prudent aim of keeping the debt-to-GDP ratio constant. A 6.9 per cent deficit in 1996 is a fiscal catastrophe; in 1975, it's conservative. This explains why the debt-to-GDP ratio actually "fell" during those apparently irresponsible Labour years.

What would be a reasonable figure in 1996? As the debt ratio is about 50 per cent, if steady growth is (as McRae assumes) 2.5 per cent, a deficit of 1.25 per cent keeps the ratio constant at zero inflation. With moderate inflation, say 3 per cent, you need to add on another 1.5per cent. So McRae's 2.5 per cent is about right (for the wrong reasons) - but you can't compare that to the higher figures from the 1970s.

Professor Simon Price

Department of Economics

City University, London EC1