Only 'Fools' would scuttle a recovery

Several countries have now started “strict economy,” or fiscal tightening, after the biggest financial crisis since World War II. The most obvious examples are Greece and Ireland. Portugal has released plans to cut its deficit to 2.8 percent of gross domestic product in 2013 from 8.3 percent this year by reducing spending on civil servants and public investment, and raising taxes on high incomes and stock-market gains.

Any cuts in spending need to be dependent on evidence of growth in private industry. Growth is what will generate an increase in tax revenue. A sensible proposal would seem to be that the fiscal and monetary stimulus should continue at least until half of the loss in growth since the start of the recession has been re-established. Later is better than sooner.

In the UK, there has been much discussion among economists, most notably in a series of letters to national newspapers, about the demand for more dramatic cuts in public spending than the overly stringent ones already proposed by the Labor government. Local authorities already under these plans are proposing reductions of 10 percent to 30 percent, which might well mean the loss of half a million jobs.

Most of these economists would leave austerity until later. Former Federal Reserve Chairman Paul Volcker, speaking in Germany on the weekend, argued that now isn't the time to dispense with either fiscal or monetary efforts to spur demand.

However, George “Slasher” Osborne, the opposition Conservative Party's shadow chancellor of the Exchequer said in a recent speech that “there is no choice between going for growth today and dealing with our debts tomorrow.”

Wrong. The UK has predominantly long-term debt that doesn't roll over any time soon, putting it in a completely different situation than Greece. Osborne was immediately contradicted by the International Monetary Fund, which rightly argued that “one of the key lessons from experiences of similar crises is that a premature withdrawal of policy stimulus can be very costly, particularly if the financial system is weak.”

In a televised interview this week, Alan Budd, an adviser for the Conservative Party, said that “if you go too quickly, then there is a risk that the recovery will be snuffed out and we will go back into a recession. I mean, what do the Americans say? 'Remember 1937.'” That was the most famous double-dip recession in history.

All this talk of fiscal retrenchment is too much, too soon. Cutting public spending will increase unemployment, unless monetary policy can be loosened to compensate, and there seems little leeway to do that. And don't imagine cutting public spending or freezing public-sector pay will be popular or easy.

About 250,000 UK civil servants went on strike this week over redundancy pay. Opinion polls have narrowed the Conservative Party's lead before a general election, which must take place before June, on the news of the opposition's austerity plans. The possibility of a minority government has investors concerned.

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