Parliament bridge

Prof Philip Booth writes for ConservativeHome

Professor Robert Barro gave the 20th Annual Hayek Memorial Lecture for the Institute of Economic Affairs earlier this week. He predicted that the next crisis would be a crisis of governments.

Robert Barro is perhaps best known in the UK for “rediscovering” Ricardian equivalence. The idea is that if government spending is financed by borrowing rather than by tax increases, it does not stimulate the economy because people anticipate higher future taxes and reduce their consumption accordingly. Strong assumptions are needed for this theory to hold in practice, but, even without those strong assumptions, a so-called fiscal stimulus is unlikely to stimulate anything other than vested interests that benefit from more public spending. Any government borrowing has to be financed and the financing of government deficits has effects on exchange rates and interest rates and leads to reduced private sector spending. The empirical evidence is pretty strong on this point, especially for countries that have floating exchange rates.

Indeed, Barro observed that the fiscal stimulus in the US had brought no real benefit. He accepted the reasons for bailing out the banks, given the systemic risks that they posed. However, the other elements of the stimulus package were always likely to have a small impact on very short-run economic growth and then have a negative impact after a couple of years. Then, for decades after, taxpayers will be paying higher debt interest as a result of the increased borrowing.

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