The UKs high levels of public spending have worsened the downturn in the private sector, according to a new study* from the Institute of Economic Affairs.
The research shows how the government's ballooning deficit has worked against the Bank of England's Quantitative Easing (QE) programme, preventing it from increasing private sector lending and economic activity.
The main focus of the research examines the relationship between new measures of the money supply such as M4X** and national income, in order to inform the debate about QE, but it is the side effect of the impact of government borrowing on the economy that is particularly alarming.
High levels of public borrowing (about 14% of non-oil GDP over the next few years) are countering the Bank of Englands effort to stabilise the economy. The analysis suggests that QE has essentially been "crowded out" by government borrowing. With a balanced budget but continued QE, gilts yields could be 3.5% lower, boosting private sector activity considerably. At the very least, funding government debt is likely to add 1.65 percentage points to the twenty-year gilt yield and induce a substantial 11.7% reduction in broad money (real M4X). In other words, the governments fiscal profligacy will put upward pressure on interest rates and downward pressure on economic activity. Government borrowing, far from supporting the economy as the government claims, is directly counteracting the beneficial effects of the Bank of England's process of Quantitative Easing.
The author, leading monetary economist Professor David B. Smith***, commented so-called expansionary policies of increasing the government budget deficit will lead to higher gilt yields, less monetary growth and weaker private economic activity, especially if bond investors believe that the fiscal stance is unsustainable. Government spending cuts will stimulate activity and employment, despite the Keynesian argument to the contrary.
The study provides rigorous evidence that the expansion of government activity in recent years has "crowded out" the productive part of the economy and lowered economic growth. Large pub