Gladstonian sound finance's last gasp ?

April 25, 2009 1:42 p.m.

The doctrine of sound finance, always balancing the budget out of revenue, reducing debt and reducing public expenditures through cuts and retrenchment in order to lower taxes is a doctrine identified with the British nineteenth century Liberal statesman and four time British   Prime Minister William Gladstone. It is a hide bound doctrine which fitted hand in glove with the nineteenth century obsession with laissez-faire and Say's law of supply creating its own demand. It was precisely this constellation of policies and homilies that Keynes confronted at the start of the great depression. Amazingly most , if not all of these doctrines reappeared with the arrival of monetarism and the new classical macroeconomics after the collapse of the Keynesian consensus in the 1970s. The current slump has eclipsed most but not all of these antiquated sentiments.
Here and there we still find robust expressions of reactionary dissent. Jeffrey Simpson in the   Globe and Mail yesterday wrote an op ed in which he argued that the ’’truth’’ was that ’’debt and deficits lead to higher taxes as night follows day’’. No Gladstonian Liberal or new classical macroeconomist could have stated the position more clearly. Robert Barro the University of Chicago economist some years ago argued the exact same position under the rubric of Ricardian equivalence-as debt today is a tax tomorrow. But is it in fact the case?

The answer is clearly no.It depends upon a large number of variables including the efficacy of a debt financed stimulus in restoring economic growth; the rate at which the rate of unemployment declines once growth resumes;the impact of this lower unemployment upon tax revenues; the policies chosen by the government of the day with respect to how the debt is financed; the impact of the restoration of spending by government on capital works and income support upon the animal spirits of private investors;the rate of technical innovation in the economy; the global pattern of trade once recovery begins; the interest rate policy of the central bank;the target rate chosen for the natural rate of unemployment or preferably the rate chosen as full employment, such choice affecting the judgement as to whether or not there is a structural deficit; the tolerance of the politicians, the financial press and the media generally as well as the public for a temporary rise in the debt to GDP ratio and the willingness to see it decline over time in return for lower unemployment, rather than in a very short period of time in return for higher unemployment. Finally, the willingness of the central bank to consider helping out by exercising a degree of quantitative easing to ensure that debts are financed at the lowest rates of interest possible.

Ideological passions being what they are however, despite the eclipse of neo-con thinking because of the slump, I am sure that there are more gasps of Gladstonian sound finance to come.

Bibliography:
Peter Clarke, the Keynesian Revolution in the Making 1924-1936, Oxford:Clarendon Press, 1988.

(an excellent discussion of Gladstonian sound finance as well as Keynes's development of his Treatise and the beginnings of aggregate demand theory in testimony , before the Macmillan committee on finance and Industry in 1930. The Committee reported in June 1931 and Keynes both testified before it and was an appointed   member of it.I had the pleasure of meeting Clarke at a conference on Keynes at the University of Kent at Cantebury in the early 1990s.

Robert Barro , Macroeconomics, N.Y.:John Wiley&Sons, 1984.

Joseph Schumpeter, History of Economic Analysis,edited from manuscript by Elizabeth Boody Schumpeter, N.Y. :Oxford University Press , 1954.( I was taught History of Economic Thought at the undergraduate level   by one of Schumpeter's students,   Ralph Harris.)