Brown’s legacy, and why Keynes isn’t the answer…

Daniel Cowdrill

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While Gordon Brown focuses on the international causes of the recession and the international solutions, he shouldn’t be allowed off the hook at home. We were told, were we not, that there would be “no return to boom and bust”? Yet ‘boom and bust’ is exactly what the Government has presided over.

It was this Government that sat by and allowed Northern Rock to take out massive credit lines to US banks and offer 125% mortgages. Even as fifty US mortgage lenders filed for bankruptcy over 2006/2007, the Government here did nothing, despite the UK market’s exposure. 

Brown failed to take seriously a report published by the IMF in March 2007, which forewarned about the UK’s specific vulnerability. Crucially, the report warned about the mortgage sector’s dependence on the wholesale market, and concluded that “given growing cross-country linkages, global risks are particularly important to the UK financial system, more for their potential severity than for their likelihood of being realised.”

Meanwhile analysts were sounding the alarm bells. Christopher Wood, chief strategist at CLSA, warned that “Some institutions have been behaving like leveraged speculators rather than banks… The UK economy is heading for a sharp shock. It just remains to be seen how bad.”

Warnings unheeded, Northern Rock’s subsequent nationalisation increased the UK national debt to 43.4% of GDP, breaking the government’s own fiscal rules and almost taking us back to the level of debt in 1997. This year could also show the biggest annual government defecit since records began, in excess of the £51 billion racked up in 1993.

The UK banking crisis, precipitated by ineffective regulation and compounded by the collapse of Northern Rock, has resulted in a credit squeeze that is seriously effecting unemployment levels, now the highest since 1997 and rising. 

In response to the ‘bust’ that wasn’t supposed to happen but did, the Government may opt for a Keynesian spending spree. However the Conservatives are right to urge caution given the immense strain that the public finances are under.  

When one adds about £40-50 billion for the nationalisation of Bradford and Bingley, £50 billion in recapitalisation packages, plus the payment of compensation to Icelandic bank depositors, we come to a national debt in excess of £700 billion, or 50% of GDP. We have not seen a figure this big since the last Labour government was forced to borrow from the IMF in 1977.

Given this, we should perhaps avoid a large scale fiscal stimulus. Big cyclical tax cuts or spending increases now would undermine stability and growth later on. David Cameron’s short -term, targeted tax cuts are probably required, or maybe a temporary reduction in VAT to increase consumer demand. Other than this, the Bank of England’s sharp cut in interest rates will stimulate growth over the medium term. However, throwing cash all over the place is not what to do.

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