Leading article: We need an open debate on our economic plight

The fiscal warnings of Mervyn King and others must be taken seriously

Thursday 26 March 2009 01:00
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Who says that deeds are more powerful than words? A remark by the Governor of the Bank of England in a House of Commons committee room has followed the Prime Minister across the Atlantic and could even end up influencing the global policy response to the economic crisis.

Mervyn King's warning to the Treasury Select Committee on Tuesday that the UK might have reached the limit of what it can safely afford in terms of discretionary fiscal stimulus has cast a long shadow over Gordon Brown's world tour in advance of next week's G20 economic summit. This tour was supposed to drum up support for another round of global stimulus. Mr King's words suggest that Mr Brown, the host of the G20, is preaching a gospel he cannot himself follow.

Despite his attempts yesterday to downplay the significance of the Governor's comments, the intervention is terrible news for the Prime Minister. Mr Brown has staked a great deal of his political capital on this meeting producing an agreement for a co-ordinated stimulus. The chances of such an agreement being reached now look considerably smaller.

The Governor's intervention also serves to undermine Mr Brown's authority within his own Cabinet. The Prime Minister is reported to be in robust discussions with the Chancellor, Alistair Darling, about whether the next UK budget should contain another stimulus measure. Mr King's intervention is likely to strengthen the Chancellor's hand.

But this struggle merely reflects a much greater battle of ideas that is being played out on the global stage. Barack Obama made a speech in Washington yesterday calling for a sustained and co-ordinated fiscal stimulus to propel the world economy out of its slump. The US President also argued that the rest of the world cannot rely on an American domestic stimulus to drag their own export sectors out of the mire.

But several European states argue that their considerable existing spending plans should be given time to work before implementing new ones. And, like Mr King, they are concerned about the size of the deficits being run to stave off economic collapse.

The question of whether the world can afford a further round of fiscal stimulus is impossible to answer definitively. Much depends on the public finances of each country. America will run a considerable budget deficit in the coming years, but has the advantage of its global reserve currency. There is always likely to be strong demand for dollar assets, no matter the size of the federal deficit. Some countries, Britain among them, clearly have relatively less room for manoeuvre.

Nations that have run budget surpluses in recent years such as Germany and China probably have more scope to expand public spending in the face of the downturn. But this picture is complicated by the uncertainty over how the markets will respond to the surge of sovereign debt that is already beginning to wash over them. Will investors avoid the debt that is perceived to be more risky? Or might investors start to get sniffy about all government bonds?

There is another risk too. In the absence of the sort of co-ordinated global spending and tax cutting programme advocated by Mr Obama, the world economy could go into a much steeper and prolonged slump. This could force countries to run even larger deficits to avoid the sort of social unrest that tends to accompany heavy unemployment. Being cautious with budget deficits at this stage in the economic cycle might well prove to be a false economy.

We find ourselves in unknown territory. All we can say with confidence is that the stakes could not be higher. Whether the fiscal hawks or doves are more correct in their analysis of the balance of economic risk, the decisions made in the coming months will affect all our lives for years to come.

Some take the view that differences of opinion among policymakers and leaders can only be bad for economic confidence in times such as these. Up to a point this is true; especially if these differences are allowed to paralyse political decision making.

But differences of opinion, such as the question of whether a new global stimulus effort is justified, can also be healthy if they challenge orthodoxies and demand reflection from policymakers.

Indeed, it is a shame such challenges to the economic consensus of the boom years - in particular the belief that we had entered a new era of financial stability - were not voiced more loudly earlier. If we had heard more from the sceptics then, the world economy would surely now be in a considerably less fraught and perilous place.

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