The problem at the heart of the argument between the economists that have recently published open letters in the Times and FT is that we all want a level of certainty that is simply not possible. The debate and conclusions that the different groups draw are based partly on what they look at when they assess the strength of the economy and partly on their judgements about what that means.
Those arguing for an early reduction of the UK's fiscal deficit tend to emphasise the importance of allowing the private market to re-find its growth path without the government confusing matters: by borrowing large sums of money, putting pressure on interest rates and creating further uncertainities about when and how they will unwind their debts.
Those arguing for a more gradual approach worry less about the impact of government debt levels on market variables and confidence. They are more concerned with being sure that there are signs of solid growth in the real economy before the government retreats to let growth return.
On balance my sense is that the risks of an early withdrawal - through its negative mulitiplier effect on spending activity - are much greater than the risks of a delayed reduction that might spread unease in the markets. I base my comment on the latest data for growth over the last two quarters which - when you look at the components of growth - indicated just how much the slight recovery we have been experiencing is highly dependent on direct public sector spending and on the government's stimulus package. If it wasn't for the public sector and the car market - both of which are supported by government spending - we would still been in recession.
To see the full figures follow this link: Q4 2009 GDP Growth - Press Release
On balance, therefore, I think those in favour of a delayed reduction are right to say what they do. Of course, things could change. Adverse market moves against the 'P.I.G.S.' as Portugal, Ireland, Greece and Spain have come to be known, placing pressure on the Euro and the Eurozone interest rate would change things. If that happened the UK would have to demonstrate that we had the deficit under control and would perhaps have to bring forward such meansures to show that we really do mean business or at least show what those plans were more clearly than any party is currently doing.
The economy is moving so unpredictably at the moment that the government fiscal position is proving highly volatile. Even between the Pre Budget Report last November and the next Budget we are likely to see some big alterations to the forecasts. It means that any 'commitments' to spend more or less on particular parts of the public sector or to make specific changes to taxation will be subject to many and frequent revisions over the coming months.
As a profession, we economists need to avoid giving the impression that our arguments are bi-polar choices between two extreme options. The path we follow over the coming year and beyond will be a nuanced and skilfully judged journey through a highly volatile and uncertain world.
During that time, it will be important to:
* keep focussed on supporting recovery in the real economy
* avoid over-reacting to financial markets and giving too much weight to their demands for certainty now about the future
* start explaining the kinds of cuts we will need to start making realising that they will be big and that, the sooner we face up to that, the sooner we can engage and get on with the task of getting through what is going to be a tough time.
Follow this link to see Martin Wolf of the FT interviewed on this subject. Martin Wolf Interview
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