False Economy economical with the economics

Duncan Weldon presents himself as an economist but he seems more and more like a bit of a hack.  Last week he wrote an article for the False Economy website with an analysis that he must know is dodgy.  Here is his central argument:

“Here we can clearly see the impact of Osborne’s changes over the next three years: public debt down by £43bn BUT private household debt up by £245bn – five times as much.”

What he’s looked at is the change in the Office for Budget Responsibility (OBR) forecasts from before the Emergency Budget in June 2010 to after Budget 2011.  He then looks at how those numbers have changed.  But that means he isn’t looking at the estimated effects of the Government’s policies but just at changes in the economic forecasts.  His analysis essentially assumes that the entire world has been held constant but for George Osborne’s decisions since last Spring.

There are good and bad reasons why a fiscal adjustment might increase personal debt.  It might mean that people think future fiscal policy is more reliable, and they can therefore borrow more securely to buy things they need or want.  To that extent, the fiscal adjustment is helping the economy recover.  But for some people, for example a public sector worker losing their job, the adjustment will be tough and they will need to borrow to cover reductions in their income.  It slightly beggars belief that the latter could be greater than the scale of the reduction in public sector borrowing though.  Is Duncan Weldon seriously suggesting that people will borrow five times as much as has been taken away, to cover their losses from spending cuts?

The colossal elephant in the room that he doesn’t mention is high inflation and extremely loose monetary policy.  Anyone who has tried to save money in the last few years will have felt like a bit of a mug.  Inflation will take a huge bite out of your income every year.  At the same time, it reduces the value of private debts in much the same way that it reduces the value of the public sector debt.  So borrowers do well out of inflation.  People aren’t stupid and respond to that kind of incentive.  As a result, higher inflation tends to mean less saving and more borrowing.

The OBR are now expecting much higher inflation.  RPI is expected to show inflation of 5.2 per cent in 2011-12 according to Budget 2011 (Table C.2) instead of 2.5 per cent in the Pre-Budget forecast in June 2010 (Table 4.2).  That will have a huge effect on expected personal debt.

Is that inflation the result of George Osborne’s decisions?  Partly, yes.  Tax hikes like the rise in VAT increase inflation.  But here are Mervyn King’s comments at the launch of the latest Bank of England Inflation Report identifying the main culprits:

“Inflation is likely to remain high over the next year, and higher than the Committee expected three months ago. That mainly reflects further sharp increases in commodity and import prices in the past three months – gas and oil prices have risen by over 15% and food prices by about 20%.”

Revisions to the inflation forecasts are the main reason, as Mike Denham set out in our briefing document after the Budget, why the public finance projections have been revised for Budget 2011 as well.  Here is a video of his speech:

If Duncan Weldon is worried about rising personal debt then he needs to advocate a tighter monetary policy.  Many members of the Shadow Monetary Policy Committee think that is appropriate, but it is certainly not what the unions opposed to spending cuts are advocating.  The fiscal adjustment might result in more personal debt, but his shoddy analysis gives us little clue of the extent.

In response to that article, Sunny Hundal wrote that he would be attending the Rally Against Debt to promote a “left alternative” of greater public sector deficit spending to avoid the personal debt that Duncan Weldon claims the fiscal adjustment is responsible for.  Hopefully others there will be able to correct him on his comrade’s dodgy article.  There is no reason why fiscal responsibility should necessarily be the preserve of the centre right, the left should be horrified that taxes will increasingly be going to pay our creditors and not for services, but some on the left need to face up to reality first.

Update:

When I wrote this post I thought you just couldn’t tell how much of the increase in the household debt forecast was down to inflation and how much down to fiscal policy.  We’ve been having a bit of a debate on Twitter and, in the course of looking into this issue a bit, I’ve found that you can get a decent idea and my case is stronger than I thought.  Look at this document, linked by Duncan Weldon.  It sets out the OBR forecast from shortly before and shortly after Budget 2010 (the one at which all this Government’s major fiscal announcements were made).

It shows that the increase in household debt resulting from the Government’s changes to fiscal policy is £17 billion.  That’s wildly different from the £245 billion increase in debt False Economy were claiming.

There may have been some policy changes that have increased the household debt forecast since then a bit, but overall fiscal policy hasn’t changed much.  What has changed is the inflation forecast and a correction for an error in the original OBR figures.  In other words, fiscal policy isn’t responsible for a big increase in personal debt as claimed.  False Economy should retract that article.

View the original article here