What next for fiscal policy?

Last week retail sales figures in January were reported to have risen by almost 1% on the year before. This was rare welcome good news, although there is more than a passing chance that its a statistical slip up (due to seasonal adjustment).

Despite this its not at all clear that the economy has turned the corner and the question that is now being discussed is what the stance of the budget should be. Budgets can be contractionary or expansionary. An expansionary budget adds more to aggregate demand than the previous one did, so if the deficit is planned to be bigger next year than this that makes the new budget expansionary.

Of course the plan is that the next budget period should have a lower deficit than the previous one. That would make it contractionary. Many feel this would be a mistake, because the economy is doing much worse than was expected when the plan was first formed.

Sadly politics makes sensible decisions on this question difficult. But at the very least there is a strong argument to say that the budget should not attempt to contract aggregate demand. This would involve not making some of the expenditure cuts planned or cutting taxes to compensate.

The linked BBC article gives attention to some options, largely proposed by Ed Balls. It is interesting to ponder what the most effective tax cuts would be and what would be the fairest. But the chances of a tax cut, beyond an over indexing of the tax free allowance, seem remote.

The BBC article is here