“Our country is facing the largest budget deficit in our modern history.” Thus did George Osborne, shadow chancellor of the exchequer in the Conservative party, start his speech at the party conference this week. He was right. The questions are what to do, how and when.
According to the International Monetary Fund, the UK’s general government deficit will hit 11.6 per cent of gross domestic product this year and 13.2 per cent in 2010. The US deficit will hit 12.5 per cent and 10.0 per cent, respectively. In 2007, UK net public debt was 38 per cent of GDP, while that of the US was 42 per cent. By 2014, forecasts the IMF, these ratios will have jumped to 92 per cent and 85 per cent. The transatlantic cousins are now the terrible fiscal twins.
In deciding what to do, we must recognise the uncertainties: we do not know how big the “structural” fiscal deficit is; we do not know how long correction can be delayed before investors lose confidence; and we do not know how far a fiscal tightening will weaken aggregate demand. But the costs of being too optimistic are likely to be higher than of being too pessimistic. That should determine how policymakers respond.
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