A university course in Keynesian macroeconomics teaches that an increase in public spending stimulates demand, unless it is frustrated by an offsetting reduction in private spending. If the government accompanies the increase in public spending by an identical rise in taxes, private spending may be deterred. However, if the government increases public spending, leaves taxes unchanged and widens the budget deficit, its policy stance ought definitely to boost demand. More generally, Keynesian theory demonstrates — or is supposed to demonstrate — that increases in the budget deficit constitute fiscal relaxation and are expansionary, whereas decreases in the budget deficit can be seen as fiscal contractions which restrict demand. If an undergraduate were to suggest in an exam essay that fiscal contractions could be "expansionary", he or she would lose marks for committing an egregious blunder.
Yet at present the British government's forward plans are to combine a large reduction in the budget deficit with a period of healthy output growth. According to official documents, from 2010/11 to 2015/16 the budget deficit — as measured as cyclically-adjusted net borrowing — is to drop from 7.4 per cent of GDP to 0.5 per cent of GDP, while national output is to rise by 1.5 per cent more than trend. Like a badly-taught student, Her Majesty's Treasury believes in "expansionary fiscal contraction".
Larry Summers — the US Treasury Secretary in the final years of the Clinton presidency — is one of the world's most prominent Keynesian economists. At a recent academic conference in Bretton Woods, he poured scorn on the notion of expansionary fiscal contractions. He condemned the British government's programme of fiscal consolidation as "an experiment" in bad economics. In his words, "I find the idea of expansionary fiscal contraction in the context of the world in which we now live to be every bit as oxymoronic as it sounds...[T]his experiment is not going to work out well."
In his column in the Financial Times on April 29 Martin Wolf, the paper's chief economics commentator, chimed in with the same message. He was particularly worried about the persistence of planned fiscal restraint, since the tightening of 6.9 per cent of GDP would be cumulative and unremitting over the five years to 2015/16. He ended, gloomily, with the observation that "stagnation, or worse, might be the best that the UK can do". Summers and Wolf undoubtedly regard themselves as the orthodoxy in this area of public policy. Economics may not be a science, but — in their view and that of other Keynesians — the lessons of textbook theory are straightforward and uncontroversial: cuts in public expenditure and reductions in deficits have deflationary effects.