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Wednesday, 20 September 2017

Mismatching Politics and Economics

It looks to me that the UK's long period of mistimed austerity is about to be replaced by a mini-boom in spending.  There is no doubt that Ed Balls was quite right in criticising George Osborne for going too far and too fast in cutting spending.  The result pushed the Bank of England to make up for the government's spending cuts with historically low interest rates for an extraordinary period of time.  Ed Balls didn't get credit for his prescience, because most of the public accepted the "common sense" approach that a time of deficit was a time to cut back on spending.

Now inflation is above the UK target of 2%, and in danger of rising further.  Conventional demand management suggests that should mean limitations on spending, but the politics is now going strongly in the opposite way, with people fed up by years of austerity demanding more spending to build public service from the ruinous state they have been allowed to fall into under the Tories.  The fall of the pound following Brexit has not helped.

The result is likely to see the Bank of England raising interest rates to compensate for increased spending and the possibility of the inflation rises becoming self reinforcing.  This is going to lead to a very nasty situation, and possibly even a period of stagflation.  Again Brexit adds further poison to the mix as the Bank uses the interest rate tool to limit inflation and possibly even an old fashioned run on the pound.  Anyone holding debts is likely to get a nasty shock as the cost of servicing the debts gets ratcheted up at a quick rate.The real architects of this situation, step forward Mr Osborne, are gone, but it is likely to destroy the reputation of whoever is in office.

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