Recently we got something of a slating from a couple of readers when we suggested now is the time for tax cuts, funded via government borrowing, coupled possibly with rising interest rates.
It is interesting to note the last few days have seen similar ideas from two different quarters, including US presidential hopeful, Barack Obama.
Writing in the Independent, Stephen King argued for a return to Reaganomics.
You may recall, back in the early 1980s, the UK was grappling with inflation – and Mrs T’s chancellor, Sir Geoffrey Howe tightened the reigns. He famously upped the rate of interest in a recession, and 364 economists signed a petition published in The Times suggesting Madge and her chancellor’s polices had “no basis in economic theory.”
In the US, however, Reaganomics, was slightly different. You may know that under Ronald Reagan, the chairman of the Fed was the strapping 6 foot, 7 inch Paul Volcker, the man who handed over to Alan Greenspan in 1987, just before the stock market crash of that year.
Volcker is not just a giant in the physical sense – he is thought of as something of a giant among economic gurus. Today, the 81-year-old advises Mr Obama.
During the early Reagan years, Volcker kept a firm leash on monetary policy, keeping interest rates high.
But, at the same time Reagan instigated wide-ranging tax cuts.
Many would argue that the consequence of these dual policies was a high dollar, and maybe the global imbalances that have resulted in the credit crunch were the result.
On the other hand, inflation was beaten, and thanks to the tax cuts, incentives for the US work force were improved. It was called supply side economics.
Supply side economics has its critics, but never forget the huge advances in US productivity that followed, and perhaps even more significantly the technological revolution that followed. The likes of Bill Gates emerged during that time of the resurgent entrepreneur.
Reagan was not all that popular in Europe – his views decidedly to the right.
But then today, Barack Obama seems to be to Europe what the Beatles once were to America.
Quite ironic then when you hear that Obama wants to cut US government spending, and use the money saved to cut taxes – ummm, doesn’t sound like a left wing, or even moderate, agenda at all.
Of course, the Obama plan has its critics. Remember George Bush senior, and his “watch my lips, no more taxes.” Many argue the Obama plan would result in surging US government debt.
But then again, there are two ways through the credit crunch debacle. You can retrench. Cut back, but face the danger of a recession just going on and on. Remember Keynes, if people start saving more, consumption will fall, job losses will mount, the greater uncertainty will breed higher saving, leading to a downward spiral. That’s why economic depression in the past just went on and on. That’s why Keynes advocated tax cuts – aimed primarily at the poor.
Obama wants to see tax cuts. No doubt his advisor Paul Volcker will expect an increase in the rate of interest to accompany these cuts.
The UK is out of balance between government and consumer debt. Our consumers are amongst the most indebted people on earth, but government net debt is modest compared to most other developed economies.
This can be corrected by increasing government borrowing, and using the proceeds to cut taxes. This will have two benefits. Firstly, as Keynes said, in times of high borrowing cutting interest rates is effective; it is akin to pushing on string. Only tax cuts aimed especially at the poor are likely to get the economy moving.
Secondly, the tax cuts will increase the incentive to work – and will surely lead to lower unemployment in the longer-term.
For as long as there is a credit crunch, such tax cuts are unlikely to feed into inflation. But, there is a danger that inflation will follow eventually; that is why the consequence of such a policy may well be higher interest rates in the longer-term – as happened in the US under Regan and Volcker.
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