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The Biggest Poser For The New Government: Where Will The Growth Come From?

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If fiscal austerity has become the "new normal" across Europe, might slow growth be its partner? The best way to starting trying to think through the process that begins with the emergency Budget promised within 50 days is to separate the cyclical from the structural. We have had a boom and a slump. Now we are going to have, not a boom, but an increasingly solid recovery, starting probably next year.

We should not rule out the possibility of a double dip to the recession, for that would be completely normal, but I think by the end of next year the growth numbers should look quite strong. We need it. We are not in the position of Greece, which many of us think has accumulated debts that can never be repaid in full. But our ability both to service a doubled national debt, and to start to repay it, will turn on our ability to generate growth. If it is a problem for us, it is also a problem in even greater measure for much of Continental Europe, where relative debt levels are generally higher and growth prospects on balance probably worse. But that is bad news too: we still sell a lot of stuff there.

So we are about to begin along a difficult path, and it is worth just making it clear why we are where we are. In a nutshell, our policy-makers confused the cyclical with the structural. They assumed that the strong boost to tax revenues during the boom years was the result of an improved structural growth rate, whereas actually it was the result of an unsustainable cyclical boom.

I have been looking at some work by Dr Bill Martin, a former City economist now at the Centre for Business Research at Cambridge University, which shows what would have happened to the deficit and to our debt had there not been these bubble years.


You can catch a feeling for this from the graphs. The blue lines show the actual deficit as published, the red line what the econometric model he has developed shows would have happened had growth been on a more sustainable path. As you can see, our "real" deficit never went into surplus during the 1999/2001 dip, and reached 5 per cent of GDP in 2005. Indeed during the long growth period between 2002 and 2007 we were above the Maastricht limit, whereas on the official figures were we on it or below it.

As a result, our national debt, far from dipping down to below 35 per cent of GDP as reported at the time, was really only briefly below Mr Brown's 40 per cent ceiling, and actually by 2007 – ie, well before the recession struck – was already approaching 50 per cent of GDP.

The point about this bit of history is that it shows that a cyclical boom can conceal a longer-term trend. So the question now, as the cycle moved into some sort of upswing, will be the extent to which the cycle will help us get our finances under control and the extent to which, on the other hand, the structural debt burden will hold back the cyclical advance.

This is a huge problem for the rest of Europe, too. The point was well put yesterday by Mohamed El-Erian, the chief executive officer of Pimco, a US fund manager:

"What is happening in Europe is a vivid illustration of an underlying theme of the new normal," he said. "There are structural forces overwhelming traditional cyclical ones."

Pimco believes that the debt crisis in Europe reinforces its view that there will be an extended period of below-average economic growth, even after global markets have rebounded from the financial crisis.

Now where has this conclusion been reached before? It appears like de ja vue reading this.

I've seen this point made loads of times on HPC and it's finally made the press.

The UK clearly has huge problems and it appears that it's going to be incredible difficult to mask the structural weakness that the UK has.

Still with the recovery locked in this is all academic.

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They've been borrowing close to 20% of GDP to get growth of less than 1%.

Take the borrowing away and you're expecting the private sector to make up the

difference. Almost impossible. Large recession still baked in.

The alternative is to keep borrowing, but this just stores up an even larger

problem for later.

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Nice of the graphs to stop in 2007.

If the models are for a more sustainable growth why are both deficit and debt worse for the bubble free simulation? That isn't sustainable in the long run. Surely a more sustainable period of growth would have come from productivity rather than debt spending (both public and private) and would have seen Government spending growing much slower. I would hate to think they have backcasted assuming the Government spending would have been the same.

"I have been looking at some work by Dr Bill Martin, a former City economist now at the Centre for Business Research at Cambridge University, which shows what would have happened to the deficit and to our debt had there not been these bubble years." Which shows what COULD have happened.

"The point about this bit of history..." which is made up. It is a counterfactual not fact.

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There's a short term problem and a longer term one.

In the immediate future there is the need for countercyclical action to stop unemployment from going way above 3 million.

In the longer term there needs to be a rethink about the economy, to take into account the resource constraints that are already evident, particularly the cost of energy. However, that would take a leap of imagination beyond the wit of most policy makers, so the future is grim indeed.

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But it's much worse than that.

Have a look at the BIS Future of Public Debt report (March 2010)


1. The graphs to show just how well placed the UK is compared to other countries (thanks Gordon, you useless sack of sh**)

2. The section that describes how important the relationship between interest rate and the growth rate

Interest rate and growth rate

When this differential is positive, so that the interest rate is greater than the growth rate, the debt ratio will explode in the absence of a sufficiently large primary surplus.

So far, the build-up of public debt in industrial countries has taken place against the backdrop of an exceedingly low interest rate environment.....

The BIS report is a must read - it was in another thread, but I wanted to highlight it again here.

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  • 444 Brexit, House prices and Summer 2020

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