House of Lords Debate: Comprehensive Spending Review
Robert Skidelsky
Hansard Column 1501-1503 | Monday, November 01, 2010

My Lords, it is a sign of the jittery state we are in that a slower-than-expected slowdown in the rate of growth is hailed as strong evidence of recovery. Of course it is nothing of the sort. It marks the end of a period in which the economy has been supported by fiscal policy, with some help from the depreciation of sterling. The direction of fiscal policy has now been reversed. In their recent comprehensive spending review, the coalition Government confirmed that they will embark on cuts that will withdraw between 1.5 per cent and 2.5 per cent of nominal demand from the economy every year for the next four years.
 
The Government's own independent watchdog, the Office for Budget Responsibility, has estimated that every 1 per cent decline in current government spending knocks 0.6 per cent off economic growth. I have never been able to understand how cutting the budget deficit in present circumstances is supposed to help employment and growth. The noble Lord, Lord Higgins, asked a very pertinent question: what do the Government consider to be the effect of the cuts on aggregate demand? Well, he did not get an answer. We are never told what the answer is. Instead, we are assured that private spending will miraculously spring to life on a wave of confidence induced by the Government's very announcement of the deficit plan. Well, the most recent data show that in September bank lending posted its largest drop by more than £4 billion since January. If that is an indicator of the private sector's new appetite for spending, I must remain sceptical about the newly fashionable doctrine of expansionary fiscal contraction, as it is known; the idea that if you contract the budget deficit, the economy will expand.
 
The present policy bears the strong personal imprint of the Chancellor. His rhetoric prepared the ground for it; he implemented it; and his political future depends on its success. Mr Osborne is not a reluctant cutter; he is an enthusiastic cutter; he is a conviction cutter. Normally I applaud conviction politics. It is rare enough for a politician to have convictions. But it is a great shame that the Chancellor's convictions are so little-rooted in theory or in experience.
 
"Even a modest dose of Keynesian spending-say, increasing it by an additional 1 per cent of GDP-is a cruise missile aimed at the heart of a recovery", the Chancellor said in October 2008, barely a month after the collapse of Lehman Brothers, with the global economy going into a tailspin. No wonder Vince Cable said at the time: "George Osborne is clearly way out of his depth".
 
I wonder what Vince Cable thinks now. Mr Osborne is clearly a man of ability and determination, but I have to say in all seriousness that in his present position he is a menace to the future of the economy.
 
The Chancellor believes that any stimulus that needs doing should be done by monetary policy. In present circumstances, that means quantitative easing, or printing money. I do not accept the argument that the last quarter's figures make this less likely. What matters for monetary policy is the state of the economy in six months' time, not six months ago. So I expect that in due course the Bank of England will follow the Federal Reserve Board and probably Japan's central bank down this path. The question is: will it work?
 
We have the experience of last year to go by. Between March 2009 and February 2010, the Bank of England injected £200 billion of liquidity into the economy. Over the year of quantitative easing, reserve balances at the banks quadrupled but the quantity of bank lending hardly budged. The same story is told by the money supply figures. In the years leading up to the crisis, M4-the Government's preferred measure of broad money, including bank and building society deposits-grew consistently between 6 and 9 per cent year on year. However, in the past 12 months, M4 has grown at only 1 per cent and M4 lending has fallen by 0.7 per cent, the weakest number since records began in 1998. What has happened is that the "money multiplier"-the ratio of money supply to monetary base-has continued to fall as banks absorb the influx of money into their reserves without increasing their lending.
 
The same story can be told in other areas. Quantitative easing failed to bring down long-term interest rates-the spread between the bank rate and the long rate hardly fell. Nor was there any evidence of the so-called wealth effect-the argument that firms use quantitative easing to buy assets and the rising asset prices enable them to raise money by issuing new shares and bonds. There was indeed a rally in the stock market in 2009 but this was accompanied by a sharp decline in company flotations. Paper wealth went up but there was no effect on corporate issues, investment and activity as in the quantitative easing storyline.
 
The failure of quantitative easing should come as no surprise to a Keynesian. As Keynes said, if money is the drink which stimulates the system to activity, "there's many a slip twixt cup and lip".
 
Quantitative easing is simply the expression of the monetarist view that, if you increase liquidity, money GDP will rise proportionately after a short lag. However, it is not the printing of money that causes GDP to rise but the spending of money, and the spending of money depends not on the quantity of bank reserves but on the willingness of the private sector to borrow and the willingness of banks to lend at rates of interest at which they can borrow. However many trillions of dollars or pounds Governments pump into the economy, this will not stimulate borrowing or lending if consumer demand is not there.
 
Ministers are constantly exhorting banks to lend. Banks say that there are no borrowers, by which they mean borrowers at the going interest rate. However, here is a suggestion for overcoming this blockage which is consistent with the deficit reduction programme. The Government should set up a national investment bank, which they would capitalise and mandate to spend £X billion a year on investment projects at interest rates low enough to fulfil the investment mandate. We are already promised a tiny prototype of this in the proposed green investment bank. Candidates for such investment would be infrastructure projects such as the high-speed rail link mentioned by the noble Lord, road building and repairs, house construction by local authorities, or projects to do with carbon emissions-insulating houses, solar panels and so forth. Lending by the investment bank would not affect the deficit and so would not spoil Mr Osborne's austerity story. True enough, subsidised interest rates imply a lower expected return on equity than from current lending, but a lower return is still better than no return, which is what idle capital now earns.
 
There may be better ways but the goal is clear: to unblock the channel of spending when orthodox fiscal and monetary policy is, for one reason or another, disabled. Unless we succeed in doing that, we will be doomed to years of interminable recession.