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The writer, a contributing editor at FT, is the chief executive of the Royal Society of Arts and a former chief economist at the Bank of England
In 1981, Thomas Sargent and Neil Wallace published a significant paper on “some challenging monetarist arithmetic.” The challenges arose from the complexities of managing monetary policy in a high-debt, high-inflation economy. Tightening monetary policy to combat inflation led to wider fiscal deficits, necessitating looser monetary policy and higher inflation in the medium term.
Today’s primary policy dilemma revolves around fiscal rather than monetary issues. In a high-debt, low-growth economy, how can fiscal policy be crafted to reduce debt without hindering growth? This conundrum is faced by many Western nations, with the UK’s upcoming Budget likely to highlight this issue.
The solution lies in focusing on fostering growth to tackle the fiscal challenge. Addressing the persistent underinvestment in technology, infrastructure, and human capital is crucial for stimulating growth. The UK, for instance, has lagged in investment compared to other OECD countries, resulting in a substantial capital gap that needs to be addressed.
A strategic approach to closing this capital gap involves increasing public investment to drive economic growth. Contrary to current debt-based fiscal rules, boosting public investment can yield significant returns in terms of potential output and national income. The key lies in aligning fiscal policies with the mission of stimulating growth, rather than being constrained by existing rules.
By adopting a fiscal rule that accounts for the long-term benefits of public investment in infrastructure and other illiquid assets, countries can create the necessary fiscal space to support growth. This approach, focused on enhancing public sector net worth, could provide the needed impetus for increased investment and economic expansion.
While concerns about rising debt servicing costs may arise, evidence suggests that a strategic investment strategy could actually lower sovereign bond yields by enhancing income and assets. Embracing a growth-oriented fiscal approach in the upcoming Budget could significantly improve prospects for both economic growth and fiscal stability.