The myth of the 'fiscal black hole'

Imagine if your monthly income after taxes was £1500, yet your monthly expenditure was £1700. You’d be running at a deficit of £200 per month and you’d agree that this is unsustainable, assuming that some kind of windfall wasn’t on the horizon. Now imagine that this unfortunate imbalance had been occurring monthly for a year, in which case you would have built up £2400 of debt. It’s a frightening prospect; indeed, you may have experienced something akin to this financial dread at some point in your life. My point is that, on a individual level, this deficit and subsequent accumulation of debt is in no way sustainable.

Now suppose that you turn on Sky News or ITV and you hear a journalist using these same terms of ‘deficit’ and ‘debt’ about UK government expenditure. It probably doesn’t cause quite the same visceral dread, though I doubt that you would feel particularly at ease either. You then see the likes of the Prime Minister Rishi Sunak and the Chancellor Jeremy Hunt asserting that the government’s largesse cannot go on. Allow me to defuse your anxiety for a moment: they are wrong.

Government deficits and debt can matter- indeed, at times they do matter- but probably not for the reason you might think. As we shall see, the main risk with a deficit is that it causes inflation, not that the government will ‘run out of money.’ This claim is one of the most toxic economic fallacies that exists, as it gives governments free rein to chronically underfund public services under the guise of a lack of money to pay for them.

Liam Byrne, chief secretary to the Treasury under Gordon Brown, famously declared in a note addressed to his successor ‘I’m afraid there is no money.’ The coalition government then presented it thus: tax rises or spending cuts. This seems to make sense. If my income doesn’t go up, I need to limit my spending. If your income doesn’t go up, you need to limit your spending. Surely the government must do the same.

But this treatment of the government as if it were an individual or household is wrong for one key reason: the UK government issues its own currency. You or I don’t have the power to create pounds out of thin air, yet the Bank of England does this every day. After all, where does the money that the UK government collects in taxes originally come from? When you think about it, saying that all government spending comes from tax revenue doesn’t make sense and it’s just as illogical as claiming that beer tokens come from punters.

I now anticipate the next objection: printing money debases the pound. This is a claim that at least has some basis in reality, but it needs to be qualified. Excessive money printing can debase a currency, but in a recession caused by a lack of aggregate demand this is not a pressing concern. Indeed, recovery from a recession requires that the government spends more to compensate for the loss of private sector activity from falling revenue, increasing unemployment, loss of wages and so forth. If both the government sector and the private sector cut back, this serves to deepen the recession needlessly by reducing output and thus contracting GDP. This was the fallacious thinking that underpinned the austerity agenda of the coalition government in the 2010s.

Thus a sensible approach to government spending would be for the government to spend more in the event of a recession, so as to avert a more protracted, deeper recession and to avert deflation. Then in times of high economic growth, the government should reduce spending in order to control inflation. The ever-increasing national debt in the UK and other industrialised nations should be interpreted as a sign of a chronic lack of demand in our economies. Our tally of the UK national debt merely tells us that the UK government is making a net contribution to aggregate demand, but calling it a debt is a misnomer.

A particularly specious argument is that the UK national debt will burden future generations. This is wrong for three main reasons: firstly, most national debt is owned by investors in the UK such as pension funds. Far from being a burden, this debt is an interest-bearing asset to these investors, which may be inherited by their children and grandchildren and will provide a low-risk, steady income for years to come. Secondly, the harm caused to future generations by unnecessary cuts to government spending in order to avert national debt would be immeasurably greater. Thirdly, government debt incurred through capital investments such as upgrading national infrastructure provides benefits to every generation.

I’m not sure if Jeremy Hunt and co. are well-versed in this subject. I suspect they follow the ruinous orthodoxy that a government must ‘balance its books’ out of ignorance. Yet it’s remarkable to see how selectively the supposed logic of fiscal conservatism is applied by governments of all stripes, and I suspect that this is an admission that even they don’t quite believe in the cause.