When Philip Hammond was appointed Chancellor of the Exchequer and signalled that he was dropping Osborne’s targets, there was much talk of an end to austerity. Parts of the media portrayed it as a repudiation of austerity’s goals, rather than a recognition that the targets wouldn’t be met. The government remains notionally committed to a balanced budget, but the Autumn Statement makes it clear that the government plans to run a deficit of £20 billion in 2020/21, a far cry from closing the deficit by 2015/16 as Osborne once promised. Achieving a balanced budget is still an important goal, and I will outline why.
The deficit is viable in the short term because the markets still have confidence that the government will pay it back, making our debt a low-risk investment; this is why the government can presently borrow with a low, at the time of writing, 1.457% yield on 10 year bonds. If we appear to lack seriousness about balancing our budget, our ability to repay debts will come into question, and rates will rise; in Greece they are 6.957%, in Brazil 11.87%.
Deficits are strongly linked to higher effective interest rates, because in effect interest rates are the cost of debt and government borrowing raises demand for debt, and higher interest rates effectively constrain growth. In other words, if we continue running large deficits in the long term, the cost of debt will rise and growth will fall, making our debts harder and harder to pay off, until we either return to balancing the budget or enter a fiscal death spiral ending with a default, like that in Argentina, which led to their economy plummeting 10.9%.
The effects of trying to fund deficits by printing money indefinitely are also handily illustrated by Argentina, which managed 38% inflation in 2014, impoverishing savers, pensioners and people on fixed incomes. I would suggest such a path is not desirable.
Certain critics on the Left will make the argument that reducing government spending will harm growth, but there is a great deal of evidence that higher government spending actually reduces growth, investment and employment. These effects can be accounted for by the impact of taxes removing money from the economy, perverse incentives provided by, and inefficiencies in, government spending, and the crowding out effect government borrowing has on private investment.
The IMF has found that the added growth for each pound spent by the government is lower in trade-orientated economies, and around zero in countries with a free-floating currency or public debts over 60% of GDP. All of these are attributes of the UK economy. In other words, moves to balance the budget won’t notably harm the economy, and may well improve it.
If we are to keep the government sustainable and the economy in good health in the long run, it is as important now as ever that the government works towards balancing the budget. Were that it would.