David Cameron needs to tread carefully.  What does warning about the risk of default amount to when you are planning to become Prime Minister and First Lord of the Treasury?

Who is he predicting is going to default?  Presumeably, he expects Labour to be out of power in a year, and then for ever.   He does not expect a default before next May, surely: if so, he could make himself even more wealthy with a straightforward bet on the UK's CDS market.  

So is he saying "The rate at which Gordon Brown is spending right now makes it quite possible that I will be forced to orchestrate a default on the UK's debt when I get into power next year?"  Hmm, Tory future prime minister claims he can't fix the fiscal mess.  Sell sell sell.

As Hamish McRae says, there is little chance that there will be a default.  Cameron's speech is just a clumsy way of gaining political points. And maybe that is fair enough, because the beneficiaries of the debt-spending are often short term, the costs long term and something is needed to bring the future to bear on the present. But, really, since default is not going to happen he ought to be phrasing his objections in terms of the unpleasant things that the Conservatives may have to do in order to meet debt repayments of about £50bn a year.  Unfortunately, spelling out their plans for spending is not part of the Conservative "how to win an election manual".

Today's FT leader calls for the political parties to make their plans for dealing with the deficit clear. However, their angle is pragmatic - like that in A Balancing Act. Yes, the deficit matters, but prioritising it above all other matters (as a powerful Office for Budgetary Responsibility might) is a BAD idea:

To date, the central feature of British political discourse has been cowardice about the deficit. But, if the main parties do decide to address the fiscal gap, they must make sure that their proposals are contingent on recovery, and are not etched immutably in stone.

Our words in an earlier draft of the piece were:

Should growth stutter again, and the large output gap lead to further deflation, it is important that the next government is not so ideologically committed to fiscal tightening that it ignores the consequences for the economy. 

Another topic:  the evidence is beginning to stack up against the claim that monetarist solutions could end the recession on their own.  I normally think of Scott Sumner here, though his thinking is too subtle and voluminous to be easily dismissed.  That post may come, eventually . . .

My criticism is that I fail to see how market participants, consumers, business investors - all the people whose individual decisions need to be summed up to make Nominal GDP - how these people can have their confidence/expectations/animal spirits boosted by monetary actions, so that they all, rationally, overcome the enormous coordination problem of not consuming during a panic like that of Autumn 2008.  Congdon seems to imply it is simple: money is produced, eventually it goes into the real economy, and as endlessly-repeated thought experiments linking numbers of cowrie shells in the economy *prove*, the price level will rise.  And since people are so, so rational, they will anticipate this price rise and, acting rationally, shift their demand forward, ending the demand-induced slump. 

To my mind, a belief in rational expectations and efficient markets rather important.  So too is the belief that the economy settles on an equilibrium close to that predicted by the central bank, staking its credibility. Otherwise, according to the theory, there is free money to be made betting against the central bank. And free money does not happen.

In the real world, what really does happen?  Ralph Atkins suggests that really extraordinary monetary actions in Europe are failing to boost credit:

Eurozone credit data still show bank lending being reined in, although the ECB argues that this is because of declining demand rather than supply-side constraints. The ECB’s last big action – when it pumped in €442bn in one-year loans – took place only in June. But so far there is little evidence that banks are oiling the wheels of recovery: on the contrary, German corporate insiders report industrial companies face widespread difficulties in obtaining credit.

This paragraph suggests two reasons why monetarist solutions may not work.  One, demand may not be there for the cash, and so no matter how "cheap" it is, no matter how high it pushed some asset prices in entering the economy, it does not become effective.  The second is the implied problem: banks get the cash, but do not lend it out.  Why?  Because their confidence is *&(*&ed, they have too little capital, they think demand is falling, and no banker is going to be fired in the next few years for being over careful with the credit. 

Nothing I have read in the last few months - as an enthusiastic amateur, willing to be proven wrong - suggests that these issues have gone away.  Print more money, it may not get used.  Someone needs to use it for it to impact on demand, improve confidence and so on.  Not just "probably use it" or "if they are rational they will use it", but "definitely use it".  The only way of ensuring this is through fiscal policy. Yes, this is orthodox thinking. But in a crisis you have one chance to get it right.  And the slump of 2008-9 is not a good time to bet on the world becoming self-fulfillingly rational in an optimistic way through sheer confidence in the ability of the central bank to achieve the NGDP target it wished.  If I were sitting in the Number 10 bunker in November 2008, watching the economy go down the tubes, I would not be telling Darling "Don't worry, by making loud assertions of our intentions and by pumping enough cash into the economy through money-creation we will swiftly convince the economy that the slump will not happen at all, because our credibility is rock-solid".  I would be saying "turn on the fiscal pump". 

Of course, the monetarists will just reply: you didn't try it enough.  Look at 1933 (though we don't in 2008 have at our disposal actions of equivalent, dramatic and straightforward force as abandoning gold ). Twice as much QE, four times as much, evenutally NGDP will rise. But when will that be?  

In the meantime, letters like this will gradually erode the confidence, asking "who is left to protect pensioners against the inflation that will surely follow in 2012". Other economic amateurs with a big megaphone will start yelling "Zimbabwe! Weimar!".   Some people actually benefit from deflation and will organise against the "unfairness" of "hurting savers to rescue the profligate".  And the exit strategy will get harder and harder to imagine or get right.

Putting all our eggs in the monetarist basket is very high risk public policy.