Saturday, 5 February 2011

Martin Wolf’s talk - impossible government projections.

Last night I saw a presentation by Martin Wolf of the FT outlining the UK government's plans for reducing the deficit. At one point he produced some graphs showing the projections upon which the plans are based. They are based on an assumption that the rate of growth of GDP and the rate of growth of tax revenue will increase at the same rate as before the crash. I instantly realised that the projections were almost impossible to occur.

The problem revolves around the money supply. Currently the money supply is being held up by the issuance of government bonds which increases government debt. If the government reduces its borrowings, which is of course the plan, then the money supply will fall unless someone else starts borrowing on a massive scale. The question now is: Who's going to do all this borrowing? Surely it can't be borrowing for mortgages - unless the government is hoping that house prices as a multiple of earnings is going to head towards Japanese levels circa 1990. Another problem not mentioned is the paradox of thrift. When the news is filled with stories of government job losses, people respond by tightening their belts. Who wants to take out new loans when you are worried about job security?

Unless the government can find another bubble to blow up (and let us pray that they can't) then their plan for reduction of government debt is guaranteed to fail.

Now one mights say - who cares about the money supply - we can still pay our taxes even if the money supply remains constant. Well the problem is that part of the projections Martin showed was a graph predicting a steadily growing nominal tax income. But if the nominal tax income rises whilst the money supply is falling then the fraction of our income paid in tax is going to be growing at a quite alarming rate. There will necessarily be a significant shrinkage in the money available for spending in the private sector. How is our GDP expected to grow at a healthy rate while the amount of money available for consumption is shrinking fast?

It just doesn't add up.

Of course if the government just printed the money debt-free instead of via the mechanism of selling government bonds, then the government may stand a better chance.

Martin Wolf is supposed to be a great economist - have I made some mistake? Comments please...