Parties seek romance with Prudence, but it may prove our end

REMEMBER Prudence, that lovely lady who captured our hearts and minds 13 years ago? Prudence did not believe in borrowing, being so well brought up that she took a pride in living within her means, adding to the household bank balance every week by spending less than she earned.

Gordon Brown had a crush on Prudence and he copied her behaviour, too; government debt was still uncomfortably high in 1997 but by 2000 it had substantially reduced.

Sadly, like so many promising relationships this one did not last and on the rebound, Gordon went on a binge. This is what presents us with such a profound policy dilemma today. Most of us agree that opening the fiscal floodgates over the past two years has been good policy. Big problems demand big answers and governments everywhere have thrown prior fiscal rules to the winds – and thank goodness for that.

As recessions gradually give way to stability, governments are pondering how to pay down their debts. But for Britain the problem is especially acute, not because we threw more at it than others but because of that decade of fiscal incontinence.

But we are where we are and the debate is now all about getting that debt mountain down. Approaching the election, all the main parties seem to agree on the objective. Those of us who thought Prudence a jolly good sort naturally incline towards a more aggressive view – if nothing else, markets would force us to get the budget under control and the sooner we could make a down-payment the better. I've argued exactly that, but now I am not so sure. Although the total quantum of wealth in the global economy will vary elastically, debtors and creditors have to balance. In the boom years, British households ran down their savings, spending more and more of what they earned until they were running in the red. The government did the same.

The counterparts for all this debt were the large creditor countries, notably China. We bought Chinese goods with money we didn't have so China lent it back to us and the merry-go-round went on. It still does, but with the difference that China's export surplus is starting to diminish.

So let's say that this external relationship is unlikely to add to the flow of credit in the economy. If the debtor/creditor patterns are to change, it will have to happen within the UK economy, without balancing flows from outside.

If the government decides to become chaste today, rather than tomorrow, how is this to be done? The political debate, inevitably, fails to see the wood for the trees; if the government is to cut its debt, someone has to be able to cut their surplus.

It is possible that in a difficult economic environment companies may see profits falling, reducing their financial savings, but the scale is nowhere near enough for the kind of deficit reductions we are "promised". That leaves only you and me; neither of us, I would bet, is minded to crank up our debts again. Been there, done that, didn't like the consequences.

So, for all the talk, it may be impossible for government debt to be reduced any time soon. A new government might try, but with no counterpart able or willing to provide a balance, it will fail. This is complex, but as fast as the government tries to cut the structural (policy-driven) deficit, the cyclical deficit will rise.

It seems a heresy, but it may be that the government should accept the inevitable – if deficit reduction is in fact impossible, it may be better not to try. If we don't try, markets may punish us with higher interest rates. If we do try, we may hammer the economy back in to recession and blow welfare budgets wide open.

If my thinking is right, one conclusion is clear: with fiscal policy out of options there is only monetary policy left. Base rates will stay lower, for longer, than the markets believe.

• Peter Bickley is a consultant economist