We learn that the government is planning to borrow more money to cut taxes. Apparently it now wishes to limit the depth and length of the downturn.
Yet it was the authorities who brought about this downturn. The MPC late in the day called time on too much borrowing in the private sector by hoisting interest rates to make borrowing dearer. The Bank of England starved the money markets of funds to prevent banks lending more, forcing Northern Rock and a couple of other banks into trouble. In 2007 we had lectures from the Chancellor and the Governor that people had borrowed too much and banks had lent too much. They were told they wrong to have lent so much , and they had to sort it out as best they could without public subsidy or intervention. The authorities followed up the sharp slowdown by demanding each bank held more capital, and leaked the story in a way which damaged bank share prices and their capital raising ability.
Now the Authorities have what they said they wanted – a collapse of private sector lending and borrowing – they are in a panic. They turned banks from profitable lending machines into unprofitable damaged institutions. They now realise they have overdone applying the brakes, just as surely as they overdid encouraging the fast build up of credit through the accelerators of easy regulation of capital and low interest rates before. So now they decide to borrow more in the public sector, to offset the lack of borrowing in the private sector. If an economy borrows too little, too many people are out of work and too many businesses go under. If it borrows too much there will be inflation, and too many strains on the people, governments and companies that overborrow and on the banks that lend them the money.
The good news is they have realised that borrowing to cut taxes is more likely to yield the results they want more quickly than a programme of public works. Big public capital projects take time to get off the drawing board. When people are starved of income and paying too much of it to the government, quite a lot of the tax relief is more likely to find its way into spending. However, with individuals and small businesses under the cosh of needing to repay loans, and worried about their own economic prospects, the government should expect some of the tax cuts to be saved. The government wanted the private sector to cut its borrowings rapidly, in a damaging way. Some of any tax cut will go towards this , but will at least speed the process up and bring forward the day when more can be spent.
The bad news for the UK is the government is already borrowing too much. The taxpayer is now being asked to be the banker of first resort and the consumer of first resort. The strains on the UK public sector will be huge. This week-end in the press there were alarming figures about how much tax revenue the government is losing from the big fall in activity in the property market (Stamp duty and CGT), from the sharp fall in financial sector profits (Corporation tax), from the big decline in high income jobs in the City (Income Tax) and from the halving of the oil price (Duty, VAT, Corporation Tax). Now the government is going to add more cuts in revenue from tax cutting proposals.
Time after time this government sets up the next leg of the crisis by the way it tackles the last one. Easy money created an inflation problem. Tight money to control the inflation created a banking crisis. Bank nationalisation to solve the banking crisis is setting up a government borrowing and debt problem. Tax cuts on borrowed money to solve the deflation will add to the questions over state credit.
We need authorities who can manage things with reasonable stability. Stability requires sensible amounts of credit and borrowing in both public and private sectors. Lurching from too much to too little borrowing in the private sector was crazy. Compounding the error by now lurching to much borrowing in the public sector is not a good idea. The government’s approach is “Let’s halve interest rates and double the amount of debt we have to sell at those interest rates”. They still do not seem to understand money markets, and the price of money.