SIMON WREN-LEWIS: A Budget that makes little economic sense

Moving rapidly to budget surplus makes us more vulnerable to the next crisis by keeping interest rates low.

In macroeconomic terms the key features of George Osborne's budget delivered today are the rapid move to budget surplus, and a rapid increase in the minimum wage. (It is best to ignore changes compared to the March budget, which was a fiction of a dying coalition.)

The two are connected: the Chancellor gave the need to move to budget surplus as a key motivation for cutting tax credits, and those cuts undoubtedly inspired his surprise increase in the minimum wage which the OBR think will cost 60,000 jobs. The pace of austerity over the next five years is to a first approximation the same as over the previous five, although it is planned to be a little smoother this time.

In 2010 the excuse for austerity was fear of the markets, although these fears were later shown to be unjustified. Today the macroeconomic excuse for austerity is more difficult to manufacture. We are told we need to bring debt down so it will not be a burden on future generations. But if Osborne achieves his goal of perpetual budget surpluses, government debt will fall very quickly. That will mean that the generation that began working as the century began will have suffered both the impact of the financial crisis, and the subsequent austerity required to bring debt down rapidly. In contrast the generation that starts work in twenty years time can enjoy the benefits of existing public capital without paying very much towards it. That does not sound very equitable.

We are told that debt must be reduced quickly to prepare for the uncertainties ahead. In the last crisis the immediate need was to support aggregate demand, and the quickest way of doing that is cutting interest rates. Interest rates are today nearly as low as they can go, and the more austerity we have over the next few years, the lower interest rates will be. This is because austerity is undoubtedly a drag on growth, as the Governor of the Bank of England agrees. Moving rapidly to budget surplus makes us more vulnerable to the next crisis by keeping interest rates low.

The Chancellor is fond of household and business analogies when it comes to government budgeting. Yet any business will tell you that the time to borrow to invest is when interest rates are low and labour is cheap. The Chancellor’s plans involve public sector net investment falling to a tiny 1.4% of GDP, which is only 60% of the average level of investment over the last decade. Whichever way you look at it, the strategy of renewed austerity makes little macroeconomic sense. But this most political of Chancellors has never worried too much about that.

Simon Wren-Lewis is Professor of Economic Policy, Blavatnik School of Government, University of Oxford. He blogs at Mainly Macro.