Into the storm

REMEMBER the Big Society? Free schools? Health reform? Nor does anybody else. With Britain having barely emerged from recession and the outlook darkening in Europe, all politics is now about the economy.

The chancellor of the exchequer's autumn statement, not guaranteed to capture the public interest, dominated the airwaves on November 29th and the front pages this week. George Osborne's announcement raised two questions which will determine the future of both the country and the government. How bad are things likely to get? And is the chancellor making things better or worse?

Back towards the thunder

The independent Office for Budget Responsibility (OBR), a newly established fiscal watchdog, provided Mr Osborne with the official answer to the first question. The OBR reckons that although growth will be much weaker this year and next than had been forecast in March, Britain will narrowly avoid a second recession. That sadly already looks too optimistic.

The OBR's forecast assumes that the euro crisis can be resolved without too much fuss, which seems increasingly unlikely—and the uncertainty is pushing the euro zone towards recession fast. Across the continent banks are finding it hard to refinance their own debts cheaply (see article). They are also shedding assets at an alarming rate in order to meet EU capital-adequacy targets by next June. Britain's banks have lent heavily to businesses and governments in the euro zone's worst trouble spots, as well as to German and French banks. The threat of a severe credit shortage will force businesses across Europe to conserve their cash and make them cautious about spending on new equipment or hiring new workers. Add in the ever more severe budget cuts planned by euro-zone countries and the picture gets even stormier.

Britain's economy has its own home-grown problems, to which the misery on its doorstep will add. Spending power is scarce. Wage growth is running at less than half the level of inflation. Public-sector workers, who staged a large strike over the government's pension reforms this week (see article), face a further two years of squeezed pay. Householders will be reluctant to dip deeper into their savings while their own debts are so high. That leaves Britain's economy dependent on foreign demand. As two-fifths of exports are shipped to the euro zone, recession there will drag down Britain's economy as well. Jobs are already being cut in London's financial district, one of Britain's more reliable export industries, because fees and commissions have dried up.

The Bank of England is likely to raise its target for “quantitative easing” (bond purchases using newly created money) above the £275 billion ($431 billion) it agreed on in October. But even swift action seems unlikely to prevent the economy shrinking for at least two quarters (enough to count as a recession). The second dip of a “double-dip” ought to be shallower than the first because there are fewer excesses to work off than after a boom. But a cumulative fall in output of 1% is easy to imagine. And recovery after that will be a long, hard slog.

Given the government's lousy inheritance in 2010 and the suicidal nature of the euro zone's leaders, it is hard to see how Britain could ever have avoided another dip. But what of Mr Osborne's competence? Has the government's budget-cutting strategy only made a bad hand worse? Has it been a “colossal failure”, as the shadow chancellor, Ed Balls, attests?

No, it has not. Mr Osborne is certainly guilty of over-optimism in the past, especially claiming that an aggressive fiscal tightening would show immediate benefits by promoting growth, rather than depressing demand. But he was right to act in 2010 to make an early start in cutting the deficit. Left untackled, the budget deficit, which at 11.2% of GDP in 2009-10 was larger than those of almost all other rich countries, would soon have undermined confidence in the government's ability to service its public debt. That faith is all the more important because of Britain's outsize banking sector.

The deficit will fall to 8.4% of GDP this fiscal year. The credibility won by such progress means Mr Osborne's plan has helped secure the country the trust of both the credit-rating agencies and the bond markets. Britain's triple-A credit rating seems assured, unlike France's (see article). Only a handful of countries can borrow more cheaply over ten years.

A little looser, please

And what of his policies now? There, we reckon he could afford to have loosened more. The plans announced this week imply that public-spending cuts will now last until 2017, in part because the OBR reckons the economy's growth potential is far more damaged than it had thought as recently as March, so there will be less growth to close the gap through increased revenues. Mr Osborne hopes to generate some growth by using private saving to pay directly for public infrastructure (see article) and he plans to use the savings made on current spending to boost capital spending on schools, roads and such like by £5 billion over three years.

Mr Osborne could surely afford to do more capital spending without jeopardising Britain's financial credibility. Infrastructure is hard to get right, but more targeted investment would add to the economy's supply potential and provide a surer boost than the temporary tax cut that Mr Balls is advocating, much of which would be saved by anxious consumers. It would not be a threat to Mr Osborne's main fiscal target or to the bond markets' good faith. And although his scheme to guarantee bank bonds to foster up to £20 billion of small-business lending is a sensible use of the state's still-sound credit rating, its success relies on the take-up by cautious banks and nervous small businesses. A small-business bank, capitalised with £2 billion of public money, would probably work better.

So Mr Osborne has not got things completely right. But this government's instincts have been saner than its big-spending predecessor's. Mr Osborne was correct in his determination to tackle the deficit quickly. The notion that he has caused the coming recession is nonsense. More flexibility is now needed. But, sadly, all the options for Britain are pretty dark.