John Hemming's Web Log John's Reference Website
Thursday, August 05, 2010
  A bit more on the financial position
Consituents remain interested in the situation for the country hence I am going to repost and update a posting I made on 23rd July (on The Stirrer forum).

The financial crisis had really four components. Three were international and one national. The international ones were

1. CDOs (the credit crunch issue - causing a big hole in banks' balance sheets). This is the issue that causes all the fuss about banks and bonuses as people were basically making money out of thin air. This is also the mistake of the ratings agencies.

2. The illiquidity of the land market and associated bubble. This has a cycle that is often international, but can be local (as was the case in Sweden). That has a knock on effect on the capital of lending institutions. It runs on about a 15 year cycle with the previous periods being 89-92 and the mid 1970s. Because it ran for slightly longer the fall back was higher.

3. Oil prices. Jumps in oil prices cause recessions. Energy affects economic activity. The calculation as to how much energy is needed for each pound of GDP is called the energy intensity of GDP.

Then nationally there is the question as to how "prudent" the government is with the public finances.

What is interesting in this situation is that the varying policy responses in different countries can to some extent be tested against each other.

You can see in this that Labour's strategy placed the UK in the same category as Ireland, Italy, Greece, Portugal and Spain rather than France and Germany.

The bank customer rescue (which did not bail out the owners of the banks viz the shareholders) was an international requirement although it raises questions about the comparative merits of bank regulation.

Then you have various demand management measures.

The big mistake people think in considering the coalition's policy is to think that in some ways it is not neo Keynsian. The proposals are to reduce the deficit, not to pay back debt. The objective is to ensure confidence in the government's (UK's) solvency. That is necessary to keep interest rates down. Ireland is having to issue debt at about 5.5% at the moment. Our 10 year rate is more like 3.5%.

On a trillion pounds of debt that difference in interest rate is £20 bn a year. A big sum to find from the cuts that Labour would be forced to bring in as a result of their having lower market confidence.

It is important that people remember that having a higher deficit also leads to higher interest rates not just a higher principal upon which interest is calculated.

In terms of the ideological "size of the state" issue. Government spending at the end of the cuts will be around the same as at the end of Tony Blair's government in 2007. I haven't managed to get the precise figures on this, but will at some stage.

Hence the govenment's financial strategy is simply a rational approach to deal with reality not an ideological drive towards a smaller state.

To be fair to Alistair Darling it appears from Mandelson's memoirs that he understands this.

Hence it is quite clear that Labour's financial strategy would result in greater cuts to public services than will be implemented by the coalition government.
 
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