Redwood wrong on borrowing
5:45 pm - March 8th 2010
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This effort from John Redwood seems to contain many of the errors that arise when economic thinking is subordinated to party political motives: confusion, lack of empirical evidence, and an over-emphasis upon the importance of policy.
He says:
Borrowing is deferred taxation…
Taxpayers will have to help repay all that debt with interest in the years ahead. They know that means tax increases to do so. More borrowing can make people more negative about spending up to their current incomes.
A reasonable hypothesis – though he doesn’t provide any hard evidence that this is actually happening. But then he says:
Much of the money the government is borrowing will be lent by banks. This is money the banks will not then be able to lend to the private sector…No wonder money supply growth is weak, and no wonder the private sector finds it difficult to borrow enough at a sensible rate.
There are two problems with this claim. First, it flatly contradicts the empirical evidence. The Bank of England’s survey of credit conditions shows that the availability of bank credit to companies contracted sharply in 2007 – before the big surge in government borrowing – and improved last year, as government borrowing soared.
Secondly, it contradicts his first claim. If people are saving in anticipation of higher future taxes, then presumably they are depositing money with banks, which they can then lend on. And if they’re saving, then they don’t want to borrow.
You can believe in Ricardian crowding out. You can believe in financial crowding out. But you can’t believe in both, as one offsets the other.
Redwood then goes on to welcome the end of QE, on the grounds that “in the longer term it can trigger a more general inflation as too much money chases too few goods.”
But how is this consistent with his claim that fiscal policy is depressing demand? If fiscal policy is taking cash away from banks, he should advocate more QE as a means to putting the cash back into banks. And if people are saving in anticipation of higher future taxes, why will they spend any increase in their cash balances?
On top of all this, Redwood is missing the elephant in the room – that government borrowing is a response to private sector failure. Banks have reduced their lending because they suffered large losses. This caused the non-bank private sector to become forced savers, as some people couldn’t borrow. The mathematical counterpart to this is that government borrowing soared.
Redwood, though, can’t seem to see this. This might be because, being a politician, he can’t see that policy is sometimes endogenous, so politicians don’t have as much free choice as they pretend. Or it might be that he’s just incapable of seeing that the private sector can sometimes fail catastrophically.
Whatever the reason, his car-crash of an argument highlights how a desperation to attack one’s political opponents can lead to some terrible confusion.
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Chris Dillow is a regular contributor and former City economist, now an economics writer. He is also the author of The End of Politics: New Labour and the Folly of Managerialism. Also at: Stumbling and Mumbling
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Story Filed Under: Blog ,Conservative Party ,Economy
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Reader comments
The Bank of England’s survey of credit conditions shows that the availability of bank credit to companies contracted sharply in 2007 – before the big surge in government borrowing – and improved last year, as government borrowing soared.
The banks were able to increase lending not due to lending to both government and private sectors, but because the Bank of England pumped some £200 billion of fresh cash into the banks.
The idea that less risky sovereign debt tends to crowd out more risky private borrowing is a well understood concept – and the fact that the Bank of England was printing cash with gay abandon does not change that underlying fact.
John Redwood is a historian who, like George Osborn, thinks he is therefore a dab hand at economics.
I suggest pointing him to the recent comments of Sir Alan Budd, chief economic adviser at the Treasury 1991-97, on the risks of a double-dip recession from early steep cuts in public spending:
http://www.independent.co.uk/news/uk/politics/tories-economist-criticises-partys-plan-for-cuts-1917785.html
Btw reportedly, Sir Alan proposed starting inflation targeting as a central feature of government economic policy after Britain was driven out of the European Exchange Rate Mechanism in September 1992.
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