Should the government look to fiscal stimulus for economic growth?

Reversing course on that programme, effectively neutralising what is now a large negative for economic growth, is what the UK needs to keep its economic recovery on track.

The level of public debt at 89 per cent of GDP looks pretty innocuous after a closer look

Beyond an end to fiscal austerity there currently seems little direct need for fiscal stimulus. However, a victory for the Leave camp in the upcoming EU referendum could change that really quickly.

Looking in more detail at the numbers, the International Monetary Fund’s latest estimate of the change in the cyclically adjusted primary balance – a measure of the government’s finances after adjusting for interest payments and the state of the business cycle – in the UK in 2016 and 2017 shows a negative fiscal thrust of about 1 per cent of GDP in both years.

In a world where UK real GDP growth has averaged roughly 2 per cent a year for the past five years, that is a huge headwind. Contrary to political discourse, it does not seem like a particularly necessary or even desirable thing to do.

On the point of the admittedly sizeable budget deficit of 4.4 per cent of GDP in 2015 and the high level of public debt at 89 per cent of GDP that proponents of the planned fiscal austerity would bring up: neither hold up to scrutiny.

First, although the budget deficit is sizeable, if we adjust for interest payments and the state of the business cycle to get a sense of the long-term state of government finances, the deficit is much smaller at 2.5 per cent of GDP. That is not a level that requires immediate action.

Second, the level of public debt at 89 per cent of GDP looks pretty innocuous after a closer look.

Not only does it not stand out in an international context, it is actually the debt service costs that matter, and at 2 per cent of GDP those are very low – and falling.

In fact, despite more than doubling public debt since 2007, the debt service cost is virtually unchanged.

Of course, low debt service cost has everything to do with the level of interest rates, which brings the desirability of the planned fiscal austerity into focus.

The fact that interest rates are at or near all-time lows is an important indicator. Obviously, it signals markets have little doubt about the solidity of the UK’s government finances and are more than willing to finance them.

There is no indication that would change if it reversed course on fiscal austerity.

Perhaps more importantly, however, low interest rates signal that savers are outnumbering investors and consumers.

Oversupply of money

There is more supply of money than there is demand for, and the UK is suffering from demand deficiency. Fiscal austerity is adding to this deficiency, as opposed to alleviating it.

At a time when economic growth is slowing down and the last growth engine in the form of consumer spending is showing signs of strain under the weight of the EU referendum, that is not a desirable thing to do.

Providing support to economic growth now by removing the drag from austerity is both prudent given the sizeable risks facing the UK economy, and easy given low interest rates.

Keeping in mind that the fiscal multiplier is close to one when short-term interest rates are near zero – normally, fiscal easing would be offset by higher interest rates, but not in the current deflationary environment – the impact would be large and immediate.

It is time the government changes its mindset and modifies its fiscal trajectory.

Wouter Sturkenboom is senior investment strategist at Russell Investments