Mervyn King, Governor of the Bank of England, has broken one of the big unwritten taboos in publicly warning the Government off any further fiscal stimulus. The deal is that just as the Government stays out of the conduct of monetary policy, the Bank of England minds its own business on fiscal matters, at least publicly. There is always the odd bit of sniping on each other's territories, made the more intense by the financial and economic crisis of the past two years, but nothing as overt as yesterday's warning has happened in ages.
Mr King must have known what he was doing in speaking so freely before MPs, and may even have had the tacit approval of the Chancellor, Alistair Darling, who has admitted his limited scope for further fiscal action in next month's Budget.
But would he also have had that same fireside chat with the Prime Minister, who wants agreement on a co-ordinated worldwide fiscal stimulus as one of the centrepieces of this weekend's G20 summit in London? This seems rather unlikely. Mr King's remarks cut directly across that agenda. Mr Brown can hardly cajole others into a fiscal stimulus he's barred from carrying out himself at home.
Reluctantly, he's being pushed by Mr King into the same camp as Germany and France, both of which have already enacted quite big fiscal packages but insisted they won't go any further. As if on cue, the European Union yesterday attempted to reinject some fiscal discipline into the system by insisting France and Germany cut their budget deficits to below 3 per cent of GDP by 2012, and Britain by 2013.
Mr King could not have been clearer in what he had to say. Britain cannot afford to go any further than it already has in attempting to spend its way out of recession. The soaraway size of the Budget deficit for the next two to three years is quite worrying enough already. Beyond the automatic stabilisers – which recognise that the deficit is bound to rise in a recession to take account of falling tax revenues and higher benefit payments – it would be dangerous for Britain to spend any more.
Nor would it necessarily do any good even if there was more scope for action. Last autumn's pre-Budget report enacted a stimulus worth approximately 1 per cent of GDP, including a one-off cut in VAT. By general agreement, the VAT cut has been a complete waste of money. There is no evidence it has stimulated spending.
I don't want to give the impression that it is unprecedented for the Governor to comment broadly on fiscal matters. It's not. As recently as last November's Inflation Report, he said that some use of fiscal stimulus might be appropriate provided it was temporary and there was a clear pathway back to balanced budgets.
What's different this time is Mr King's warning to the Government not to go any further than it already has. There's still quite a bit in the fiscal pipeline left to come through. The Governor doesn't want any more on top.
Should he be saying these things? Letting the public finances go to hell in a handcart is surely a matter for Government and voters? Well, maybe he should be keeping his counsel, but Mr King was asked a straight question, and it would have been disingenuous to have given an answer he didn't believe in. What was he supposed to say? Go for it boys?
In the rush to save the world from a second Great Depression, it sometimes seems that almost anything now goes. The old disciplines have been thrown to the winds with little if any thought given to how we are going to extricate ourselves from the mess we are getting into. Already, years of austerity and high taxation may await.
What's more, quite enough is being done by way of monetary stimulus without piling new tax cuts and public spending on top. The use of £150bn of "quantitative easing" blurs the distinction between monetary and fiscal policy since the effect is to allow the Government partially to underfund the Budget deficit. In the Governor's view, the monetary stimulus already being applied limits the room for further fiscal stimulus, and he must be right. To have both is not just unaffordable, but potentially highly dangerous.
It's only a pity Mr King didn't sound these same warnings three years ago when they were still capable of doing some good. Instead of which the Government was allowed to go for broke, when it should have been reining in.
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