A moment of nostalgia: doing out my mother’s loft the other day, I happened across my old copy of the Treasury’s Economic Progress Report of March 1981 (do we still have the Report? One imagines it has gone the way of sweet cigarettes and flared trousers). Devoted to Geoffrey Howe’s controversial budget of 1981, it is both hilariously dated and bang-up-to-the-minute.
In the Autumn of 1980, expenditure hawks had lost some battles in cabinet, and Howe responded by raising taxation in 1981. The Report sets out Howe’s rationale.
With no budget changes, the 1981-82 PSBR [Public Sector Borrowing Requirement] could have been expected to be about £14 billion [we borrow that every month now!]. Such a borrowing requirement would have been unacceptable not least because of its implications for interest rates, bearing in mind the need to help redress imbalances within the economy. In the Chancellor’s judgment, given the background of recession, the extra severity of which is likely to add some £3 billion to the 1981-82 PSBR, it is right to provide for a PSBR of about £10½ billion, a little over 4 per cent of GDP. The tough tax measures needed to achieve this were, the Chancellor said, the measure of the Government’s determination ‘to maintain the monetary and fiscal framework necessary for the reduction and defeat of inflation.’ ‘Equally’, he said, ‘they reflect the bill that we as a nation must meet if we are to pay for the high level of public spending.’ (p.2)
There were many voices against the deflationary budget, including a famous letter to the Times from 364 economists (including Mervyn King) insisting that it would deepen the recession, have no effect on inflation, and lead to political instability and long-term unemployment. They were correct on the final point, but wrong on all the others. The recession hit bottom shortly afterwards, the economy improved dramatically and the letter became a standing joke. Their cause was not helped by the assertion that “there are alternative policies” without explaining what they might be.
The key factor of which they had not taken account, and upon which Howe (and Thatcher) were completely focused, was the credibility of the government’s anti-inflation policy. And this is where we find the parallel with today’s politics. Current Chancellor George Osborne (then nine years old, and still saddled with the moniker ‘Gideon Osborne’) has a credibility issue of his own – the credibility of his programme to reduce the deficit.
The calls to cast this aside in order to “promote growth” have grown over the last few weeks, especially after it was revealed that Britain was back in recession. However, the dusty document I unearthed last week reminds us of the importance of credibility, even though it is hard to quantify. Of course Osborne could boost short-term growth with some kind of spending splurge – but without the fundamentals in place, its temporary nature will become pretty obvious pretty soon. Exactly, in fact, as we saw in the Eurozone with the European Central Bank’s LTRO programme of making low-interest loans to Eurozone banks; the moment the cash had been doled out and absorbed (€1 trillion borrowed by commercial banks), the bond yields of Spain and Italy began to creep up once more.
That is not to say that Osborne should not try to pursue long-term growth – of course he should, ideally with supply-side reforms rather than hard cash. The lesson from Howe and Thatcher over thirty years ago is of paramount importance though; credibility is an intangible yet essential asset which will bring both economic and political benefits if one can hold one’s nerve in the face of negative headlines.
We can’t forget that if the bond markets lose confidence in the UK economy, interest rates will rise rapidly with potentially catastrophic consequences for mortgage holders, small businesses and the health of the nation. In today’s context, the determination to see the deficit down has to remain rock solid.