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

But the absence of one can

Austere stimulation, old boy

Things get a little different if most of the borrowing is from the domestic population (Italy and Japan say). Because when you collect the money as taxes, yes that's austerity just like the deficit is stimulus. But paying the interest out to domestic households is, in equal quantity, stimulus not austerity. However, if you're paying that interest out to foreigners then that's money that leaves the domestic economy. And that is austerity.

And austerity shrinks the economy, so now our economy is smaller next year and yet the debt is still there as an even greater proportion of it. We're stuck in a spiral.

At which point it matters whether you're borrowing in your own currency (whether from foreigners or not) or borrowing in another currency. Because if it's your own you can just print more. If someone else owns the printing press you can't.

Sure, printing more money leads to inflation and then hyperinflation eventually (1920s Germany, post war Hungary, Zimbabwe, where they took it to such an extreme that they kept printing until no one would sell them any more ink for Z$s, ink to print Z$s paid for in Z$s). We don't generally think that's a good outcome.

So, deficits not much of a worry, sometimes they're a good idea, the national debt is important at the extreme so, why is everyone shouting?

Well, if we want to be fair to Osborne we should mention that while 90 per cent might not be the number for the debt to GDP ratio getting dangerous, 120 per cent is thought to be. At least borderline. And the deficit for a few years now has been in the 5-10 per cent range of GDP and the debt is climbing toward the 80 per cent level and ... well, perhaps we might want to do something before we really do reach the danger zone.

But that is being kind and that is also the economics of it all, which really isn't what anyone is shouting about, anyway. What's really at the core of the argument is politics.

There's those who think that Britain should be a smallish state sorta place. Myself, given those leather shorts arpeggios, am a very small state kinda guy. But fair enough, most don't agree with me.

The current Osborne target is for government to collect and then spend, including all of the welfare system transfers as well as actual spending on actual government consumption, some 35 per cent of GDP, of everything that everyone produces in the country in a year. This is a bit low by normal OECD (ie, other rich countries) standards but not outrageously so. It's about the level we had in the UK between 1997 and 2001 (nice bit here, courtesy of the Guardian).

New Labour was elected and their basic proposition was that Britain should be a rather higher government as a proportion of GDP sort of country. This isn't particularly right or wrong, it's a political decision, after all. But something in the 42-44 per cent range of GDP is the sort of thing that the British social democrats (ie, those who look to the Nordics and so on, not necessarily the people who were in the party of that name) think should be about right.

And that's really what the fight is about here in political terms. Not whether deficits should exist or what the correct level of the national debt should be. But what should be the level of public spending as a proportion of the economy. Those who think spending should be higher are arguing that we should run a deficit to maintain those essential public services (ahem).

Osbo munching on a posh, take-away burger

Those who think the state should be smaller are using the excuse of the deficit to curb spending on such public services. And if that's all it were then obviously the small state people would be the evil bastards here.

However, travel back 12 to 15 years and we were all having a very different argument. At that time we had, for a couple of years at least, a final surplus. And as far as we could see into the future we were going to continue to have one. So, turn on the spending taps! The small state people saying, well, no, we still want a small state. The larger state people saying but look, we got loadsamoney (I particularly recall Graun columnist Polly Toynbee insisting we could end child poverty), so why worry?

And of course the small state people are today saying, well, yes, we had loads at the top of the longest peacetime boom the country's ever seen but that's not when we should be bringing in new long-term spending commitments. Because the bust will arrive at some point.

This is sometimes known as the Keynesian ratchet. Boost spending in the good times, then argue vociferously that it cannot be cut in the bad. Because cutting spending in the bad is austerity and that's doubleplusungood. And thus does the size of government ever ratchet up which is the point and purpose of the tactic.

OK, that last is me being even more cynical than usual. But it really is true that there's two entirely different arguments going on here. The first is the purely economic one of what's the right sized deficit for the state of the economy, how much and when do we have to worry about the national debt? And then there's the second which is really between those who think the state should be smaller than it currently is and those who think it should be larger.

And it's the second argument that is really being played out across the political scene, each side borrowing whichever points and principles from the economic argument seem most likely to bolster their story at any one time. For the economic arguments can and possibly should inform whether we should shrink that deficit, stop adding to that national debt, quickly or slowly, in what manner. But what should be the role and size of government is a purely political question.

As such, of course, that second question is entirely up to you, you in aggregate in your position as voters. ®

Want to hear more from Tim in person, or to tell him why he’s wrong, face-to-face? Come and hear Tim at the Reg’s Summer Lecture season as he explains the absurd economics underlying the technology industry by taking us on a journey around the world’s rare metals hotspots. Full details here.

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