Brown and Darling are about to abandon their so-called fiscal rules and increase government borrowing. They think that they can avoid a recession by maintaining a high level of aggregate demand.
This spend-your-way-out-of-recession has been tried many times before. In fact, it was tried only a few months ago by Bush. Under his fiscal stimulus package, every taxpayer in the US received a cheque of a couple of hundred dollars from the tax service. The idea was that people would go out and spend the money as soon as they received it.
Unfortunately, it didn't quite work that away. Here are a couple of charts that illustrated what happened. The first chart tracks personal disposable income. The fiscal stimulus package is clearly seen as a blip during the second quarter of 2008.
We can also see the stimulus package in the US savings rate. Rather than spending the cheque, most people actually saved it.
What happened to household expenditure? In real terms, it has been falling for a couple of months.
Declining consumption expenditure pushed economic growth into negative territory. Third quarter GDP data confirmed that the US economy was contracting and settling into a prolonged recession.
The failure of the fiscal stimulus package should be no surprise. Most taxpayers understood that the cheque was paid for by additional borrowing, and that eventually, they would have to pay the cheque back in the form of higher taxes in the future. Therefore, most Americans did the sensible thing and saved the money.
It would be no different here. Brown and Darling are already building up a huge fiscal deficit for 2008 and an even bigger one for next year. Eventually, this hole in the government accounts will have to be covered by higher taxes. Everyone knows this, and will act accordingly.
This should be no surprise to anyone with even a passing knowledge of UK economic history. During the 1970s, both Labour and Conservative governments tried to spend their way out of trouble. The end result was rising inflation, recession and rising unemployment.