NEVER MIND the B*LLOCKS Osbo peddles, deficits don't really matter

But the absence of one can

Worstall @ the Weekend What with another budget just coming up, to correct the one that chancellor of the exchequer George Osborne kidded everyone with before the election, it might be time to answer the question of whether deficits really matter?

For Osborne is most certainly going to continue shouting that they do and, equally certainly, everyone to the left of Genghis Khan is going to be shouting that they don't: even that they're beneficial. I was also asked this by an old friend just recently for the counter-claims were getting confusing. And given that he's been a banker these past 20 years and if they don't know ...

The truth is that there's two entirely different arguments going on here. There's an economic one and that's conducted to one set of rules. And in terms of actual real government and central bank stuff everyone really is using just the one set of rules, albeit with minor variations.

Then there's the political argument, which is being run on entirely different lines. Each borrowing whatever part of the economic story seems suitable for their purpose at the time. And equally ignoring the bits of the economic story that seem inconvenient to their preferred arguments at any one time.

In that strict economic sense: government spends more than it collects in taxes. Oh deary me, what tragedy. This is about as worrisome as my borrowing a tenner until payday. Because that's what is being done, some borrowing is being done from future state revenue to spend now. So Osborne tramping around the country shouting that we've got to close the deficit isn't quite what economists would worry about.

Indeed, there's another way of looking at it (and here everyone is working from a reasonably standard Keynesian of some form economic textbook, so pretty much everyone working in the field agrees), which is that, when we're in recession, a deficit is a very good idea indeed.

Borrow money, spend it into the economy, this boosts aggregate demand and reduces either the depth or the duration of the recession. Admittedly, there are some economic schools that don't agree, the Austrians, for example, (no, not yodellers in lederhosen, a school of economic thought) for they insist that the recession is necessary to purge the economy of the excess accumulated through the boom.

Only when all the previous malinvestment is liquidated can we get back to growth. Despite my often lederhosen ways, extending perhaps to an arpeggio or two rather than the full yodel, that seems a bit harsh to most. A deficit will reduce the pain of recession, that pain being done to real human beings, let's have a deficit.

But a deficit in itself being harmful? No, not really.

What does become important is the national debt: the accumulation of all past deficits minus whatever surpluses anyone has ever run (no, don't laugh, it's happened a few times since World War Two in the UK. Under Clement Atlee, Nigel Lawson and, amazingly, Gordon Brown).

Now, there's an argument about at which point the next thing happens. Professor Carmen Reinhart and one-time chief economist of the International Monetary Fund, Ken Rogoff, insisted that the trigger point was when the debt was 90 per cent of GDP. That turned out to be an Excel error in part. And they didn't differentiate between people borrowing in their own currency and borrowing in another.

But all will agree that at some point that debt will rise up and swallow the rest of the economy. At which point a little detail.

We differentiate between a primary surplus (or deficit), which is before interest and capital repayments on the national debt and a final surplus (or deficit). So, say that the debt is 50 per cent of GDP, interest rates are 4 per cent (just to make the maths easy) so we've got to find 2 per cent of GDP to pay the interest bill. This is below the combined inflation rate and growth rate (or what we call the nominal growth rate) of the economy and our bill isn't going to get any larger.

We might even borrow to pay that interest as with that nominal growth the debt to GDP ratio isn't going to grow. And it's not terribly difficult to run a primary surplus of 1 per cent or so of GDP so we can possibly even pay down that debt a bit.

Now run things again: debt is 300 per cent of GDP (not far off where Greece got to at one point) and interest rates are 10 per cent. We've now got to find 15 per cent of GDP just to pay that interest bill. That is, we've got to pull out in tax 15 per cent of everything that everyone does in the entire economy and send it off to those bondholders. That's 15 per cent of the economy that's got to be taxed and not spent on public services.

Simply not going to happen: the general thought is that you might manage a 2 or 3 per cent primary surplus for years, but no more than that (some countries managed a bit more in the run up to the Euro but some of them were, umm, lying, Hi! Greece! How are ya?).

People just won't put up with it.


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