By Anthony Gillham, portfolio manager fixed interest, Skandia Investment Group
Yet another set of terrible GDP figures has caused many to call on the Chancellor to drop his fiscal guard and change tack on facilitating economic recovery.
Compared to the US, which continues to try and spend its way out of trouble, George Osborne’s laser focus on austerity seems peculiarly eccentric and British.
However, the problem with the argument for more spending and less austerity, advocated by so called “Keynesians” after the economist John Maynard Keynes, is that it doesn’t work. The Keynesian argument is filled with anecdotes but ignores the powerful lessons that history has to teach us if only we were willing to look.
Over the past 60 years there have been ten recessions in the US followed by numerous attempts by government to use tax and spending, or fiscal policy, to kick start economic growth. However, research shows that there is no relationship between changes in per capita GDP growth and changes in US government spending over this period, although it does show that government spending per capita has quadrupled over this period in real terms!
When it comes to paying for stimulus spending through taxing the wealthy the results are even more damning showing a negative relationship between the top rate of tax and per capita tax receipts.
In light of this analysis, today’s Keynesians advocate what amounts to one hell of a gamble with the bond market implying that Osborne must stay the course. Any perception that UK plc is going on a spending spree might cause government bond yields to rise, hence costing the Government more to borrow. Whilst a ratings agency downgrade is unlikely to prove a catalyst for significantly higher gilt yields, the bond market is likely to be less forgiving of a wavering Chancellor; hard won credibility with markets once lost is difficult to regain. Just ask Spain.
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