Keynesian theory and public borrowing

RBC Capital Markets have a chart which illustrates nicely what today’s public finances figures mean for the Chancellor’s deficit reduction strategy:

They’ve stripped out all the distortions such as the Government taking on the assets of the Royal Mail pension fund, plus all the revenues coming into the exchequer from the bailed out banks.

What it shows is that annual borrowing has been falling in every financial year since 2009-10. But this year, since March, things haven’t been going well. Borrowing over the first two months of this financial year has been higher than the same two months last year.

Unless the economy picks up, that green line could end up well above that red dot, representing the Coalition’s target, by March 2013.

Keynesian theory says that overly hasty deficit reduction can be counterproductive. This is because cuts and tax rises depress overall economic activity and thus tax receipts. Depressed activity also pushes up unemployment and results in a bigger benefits bill.

The latest figures seem to support that. Income tax receipts in May were down by 7.7 per cent on May 2011 (£9.6bn vs £10.4bn). And welfare payments were up 11.6 per cent (£16.3bn vs £14.6bn)

The Treasury says that the welfare payments were artificially inflated in the month because a lot of tax credits went out in May for various reasons that would normally have gone out in June.

But it has no explanation for the weak outturn in income tax.

Both the Treasury and the Office for Budget Responsibility warn against placing too much emphasis on one month’s figures.

Fair enough. But keep watching that green line.

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• marqueemoons

  Thanks for this Ben. It’s good to see Keynes has his champions – it seems like most ‘financial media experts’ seem to have been wooed by the Right long before they got near a paper and that their sole role is to demean Keynes. Keep your analysis coming, it’s really important to make these points.

• http://www.facebook.com/people/Chris-Martin/100001656357022 Chris Martin

  But Keynesian economics argued that Governments should act as a balancing mechanism – underspending and building reserves when the economy is doing well and then spending more than it receives when the economy is doing badly. His model has never been followed as Governments have been in deficit most of the time. It was also a theory developed at a time when the state was relatively small – now we have a state that is more than half of the economy and already massively in debt: there is no room for greater spending. indeed it is already being ‘keynesian’ in a strict sense, because the UK Government is already spending £17 billion a month more than its income. if we spend more we are not just burdening our children with debt, it will soon be our grandchildren and great grandchildren.

• http://www.facebook.com/helen.wilcox.7 Helen Wilcox

  We live on a finite planet, with finite resources – the “economy” (somebody’s ideology), and our “systems” (somebody else’s ideology) has the vast majority believing that economic growth is the only way forward. I am not an economist however I perceive the “economy” in the same light as an elastic band – stretch it too far and you’re buggered, keep stretching it further and it will snap. We are currently in the buggered stage and not too far away from the snap – it’s time to get rid of the elastic band, stop repeating the same mistakes and come up with some new ideas.

• http://twitter.com/rober1236Jua Bob

  Chris Martin

  Okay so you say the state can’t borrow any more? But it just did. In May 2012 borrowing rose significantly, so clearly (in that strange place call reality) spending can and does go up all the time. Obviously it is possible for the UK government to increase spending, the Tory government just did.

  As for the credit strapped UK government, the UK government is rather proud of its low interest rates. The UK can borrow money at 2%. That is 2% over 10 years. That is a interest rate of 0.2% per year. So it sure seems like savers all over the world are more than happy to loan the UK government at historically low interest rates. Does not sound like Greece or Spain to me. And before you say ‘well the cuts made that possible’ this dramatic decline in interest rates started under Brown.

  There is plenty of money sitting around looking for safe harbors.

  So since the UK can borrow more, and is borrowing more, and seems to actually not even be able to prevent itself from borrowing more, than maybe it should give up this austerity game and just admit the truth: either by being dragged in to it through the consequences of austerity side-effects or via a deliberate policy of growth the UK can not avoid getting in to more debt in the short term.

  Once you face up to reality than the option of a growth policy looks better. Take the debt now to cut business taxes and VAT, and borrow at these low interest rates to develop public services and pass savings on to households and businesses. Take a hit now but get the economy moving. The Tory Austerity option is just letting the debt rise.

• http://www.facebook.com/people/Chris-Martin/100001656357022 Chris Martin

  Bob, Well, yes, the Government probably could seek to borrow more, but remember it needs to keep this within limits. Historically, borrowing is already immensely high (even compared to emergencies such as the World Wars) and remember that this money has to be borrowed from people (your and my pension funds and others) who are willing to lend it to the Government. At the moment demand to lend Governments is high because the returns on other investments are low – we would be unwise to assume that this will apply for ever. There is also a structural risk that Government borrowing drives out the ability of the private, productive sector to borrow money. We could easily find ourselves at some future point in which our debt repayments become a major part of Government expenditure – as they did in the 1970s. This leaves future generations with the burden of our over expectations of Government

• Midwinter1947

  A worthwhile warning, but please stop characterising the private sector as ‘productive’ and thereby implying that the public sector is not. There are many areas of the public sector which are not only directly productive but earn foreign exchange as well – and that’s in addition to the provision of services and support for private industry and commerce, without which they would not be able to operate effectively.