Gordon Brown, the British Prime Minister, is in big trouble. It turns out that a medium-sized industrialized democracy like the UK can be run in pretty much the same way as a traditional emerging market – fiscal irresponsibility (cyclically-adjusted general government deficit now forecast at 12.2 percent of GDP for 2010) gives you a boom for a while, but the eventual day of reckoning is economically painful and politically disastrous. If you also need to deal with an oversized bubble finance sector, that makes the adjustment even more painful.
It is of course sensible to use fiscal stimulus to offset a fall in private demand, and to some extent this can be effective – with a lag. But if you lose control over public spending and borrow too heavily (helped by the fact people like to hold your currency), it ends badly.
From the beginning, we’ve expressed concern here that the entire Summers Plan was overweight fiscal, i.e., not enough resources for recapitalizing banks and addressing housing directly (for the context of this assessment, see our full baseline view). Back in December/January, this was a strategic choice worth arguing about; now it’s a done deal and following the (very) limited recapitalization outcome of the bank stress tests, it seems likely that household and firm spending will remain sluggish. If that is the case, the Administration’s logic implies throwing another big fiscal stimulus into the mix – and the Summers’ team is already preparing the groundwork.
The IMF is now warning against the risks of this approach, albeit using carefully worded language. Continue reading “Is Larry Summers The Next Gordon Brown?”