Throughout this crisis, one simple refrain has kept echoing again and again in my head: they’ll inflate it all away.
When you consider the size of the debt the Government is faced with, and the fact that historically governments have often chosen to debauch their currency rather than directly defaulting, it is tempting to conclude that, in a few years’ time, we will face a massive dose of purposefully-generated inflation as the Government tries to reduce debts rather than taking the slightly more painful route of cutting spending and raising taxes. It’s probably fair to say from having read your comments that most of you think likewise.
But can they actually manage it? This was the question I tried to tackle in my column this week. My feeling is that if the Government felt it could get away with it, it would generate bumper inflation – double digits if necessary. The problem, I discovered, is that the way its UK liabilities have evolved means that whereas this might have worked at eroding away the debt in the 1970s, it would not today: four-fifths of the UK Government liabilities (on and off balance sheet) are inflation-proof. I don’t know whether people, in the market or even the Government, fully appreciate this.
Now, such an obstacle could be overcome, but only by rewriting various contracts. In rising order of difficulty, you’d have to remove the inflation-link built into the state pension (or, more feasibly, raise the retirement age faster and so erode the eventual liabilities). You could cut public sector pension payouts for existing state workers. You could rip up the terms on the private finance initiative so they are not inflation-protected. You could do the same with index-linked gilts. Another possibility suggested by my colleague Jeremy Warner is that perhaps the Bank of England could simply cancel the gilts sitting in its vaults as a result of quantitative easing – outright monetisation of the deficit.
The problem is that doing all of this is significantly closer to outright default than the rather more subtle, insidious method of just inflating away the debt itself.
I should add that none of the above is something I would recommend – in fact some of it is outright horrifying. However, we ought, pragmatically, to be aware of the restraints facing the Government, and try to anticipate the ways that it might try to tackle the deficit, if it is too cowardly to slash the deficit Ireland-style. To my mind, fiscal consolidation (alongside relatively loose monetary policy) is the answer. But the Government should be getting on with it quicker or else we will have to face the unholy trinity of rising interest rates, rising taxes and falling spending all at once.
PS I know that some of you have, to put it lightly, disagreed with the policy of quantitative easing, a policy I’ve been supportive of right from the start. Contrary to some other commentators, I don’t believe that QE, as it has been carried out so far, has been covertly designed to try to generate the kind of debt-destructive inflation I’ve talked about above. Insofar as it has had an inflationary effect, it has only counteracted the immense deflation generated by the worldwide economic crisis.
This is very similar to what happened in the 1930s. America deflated (facing the depression as it stuck within the gold standard); Britain inflated. Except that this wasn’t 70s style inflation, it was merely the avoidance of an outright debt deflation spiral. This is a critical difference.
But supporting the policy so far doesn’t imply supporting it until kingdom come. The moment there is any hint that the Government is attempting outright to monetise the deficit (Mugabe-style), be assured we will be on it like a nasty rash.
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