Saturday, April 18, 2009

Cheap credit depends on small state sector

Welsh academic’s lesson from history suggest austerity will follow Darling

Comparison with post-war interest rate management to enable cheap credit. Suggests that low interest rates and low inflation must be credible over the medium term, otherwise investors will keep away from the markets. Between 1947 and 1949 such belief was lost and the pound lost a third of it's value (sound familiar) as yields on long term gilts rose to 3.6% away from the 2% target. For the current government to avoid a similar outcome then “the only way in which a cheap money policy can be maintained is through the achievement of a sufficiently large budgetary surplus”.

Posted by stillthinking @ 09:40 PM (798 views)
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3 thoughts on “Cheap credit depends on small state sector

  • stillthinking says:

    I am at a loss to explain why the pound has strengthened recently.
    The UK government have shown absolutely no sign or inclination to cutting the size of the state sector, and indeed, seem to hold as a political belief that state expansion and state intervention funding are the only roads to recovery. Further as has been pointed out, the only support sterling has, is the continuing inflow of foreign funds. Things that don’t last forever, don’t last forever.
    Perhaps the original sell-off of sterling was too excessive and is now correcting.
    While personally I feel that the strengthening deflation will last for some time, when that ends with either an external or internal recovery, the UK must have an inevitable inflationary problem. For me sterling looks as though its long term trend is to lose yet more value.
    Perhaps the opinion is that Darling has no choice whatsoever but to make substantial cuts in the budget. I really just don’t see New Labour doing that though, and the idea of cutting state expenditure sufficient to maintain a small surplus is laughable. Not even vaguely possible.

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  • Great post little professor!

    “So what are the implications for Alistair Darling as he seeks to emulate his post-war Labour predecessor in kick-starting the economy by creating credit to drive down interest rates?

    The key lesson is the strategy may work for a time, but it can only be sustained if accompanied by a tight fiscal policy, such as that pursued by Chamberlain in the mid-1930s. In fact, the fiscal policy being pursued by Gordon Brown and Alistair Darling is looser than any previously experienced in peacetime history – with the budget deficit forecast to rise to £150bn, or more than 10% of national income, next year.”

    That sounds like a recipe for higher interest rates and inflation to me. The timing of the next election is especially unfortunate; the temptation for NuLabour to keep spending may be irresistible.

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  • Also like this bit. The same cannot be said of the current government in this country.

    [blockquote]
    “How did Chamberlain carry it off?

    “The growth of confidence in the government was a fundamental factor in the fall in interest rates, and that was caused by the belief that the government had firmly adopted the principles of orthodox finance,”[/blockquote]

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