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All three leaders failed the exam

It has come down to the final stretch and my team, Cardiff City, is in the play-offs for promotion into the Premier League. It is exactly 50 years since the Bluebirds were last promoted to the top level. So fingers crossed. Oh, and there is the matter of that other play-off coming to a close - Clegg and Cameron vying to get into the premiership; Brown trying to avoid relegation.

On 29 April, I watched the debate on the economy from afar, struck by the broad political consensus (which I don't share) on the need for draconian public spending cuts and tax increases. The slashing frenzy was given fresh impetus by a report from the Institute for Fiscal Studies (IFS). Its director, Robert Chote, argued in a press briefing that "repairing the public finances will be the defining domestic policy task of the next government". Dealing with the widespread social unrest that such policies will generate seems a more likely candidate.

The Bank of England governor, Mervyn King, even warned in leaked comments that the fiscal retrenchment he thought was necessary would be so unpopular, it would keep the party that introduced them "out of power for a whole generation".

The IFS calculated that, in real terms, the Conservatives would have to cut spending on public services in their unprotected areas by £63.7bn, Labour by £50.8bn and the Liberal Democrats by £46.5bn between April 2011 and March 2015. It estimates the Conservatives have announced measures that would leave a shortfall of £52.4bn, compared to £44.1bn for Labour and £34.5bn for the Lib Dems.

Things could be worse

These are enormous sums of money. To put them in perspective, the Treasury estimates that in 2010/2011, spending on health is £122bn, education is £89bn, defence is £40bn, transport £22bn, public order and safety £36bn and personal social services £33bn. Therefore, to make these savings, if they were to be delivered by spending cuts alone, the Tories could eliminate all spending on social services plus transport, or alternatively cut out all spending on public order and safety, as well as around half of defence spending. VAT receipts for 2010/2011 were projected in the Budget to be £78bn, and income tax £146bn. So another way to raise money to cut the deficit would be to introduce huge increases in VAT, most likely to 25 per cent, combined with spending cuts. Sound like a nightmare yet?

And that is the best-case scenario; things could plausibly be a lot worse still. All of these projections depend on the economy growing rapidly out of recession in 2011 and 2012. The Treasury GDP forecast for 2010 is of growth between 1 and 1.5 per cent. GDP is then forecast to grow by between 3 and 3.5 per cent in 2011, before rising to between 3.25 and 3.75 per cent in 2012.

On 21 April, the International Monetary Fund cut its 2011 UK growth forecast to 2.5 per cent from 2.7 per cent and held its prediction for expansion this year at 1.3 per cent, as domestic demand "remains subdued". The National Institute of Economic and Social Research (NIESR) is forecasting that GDP will grow by 1 per cent this year, picking up to 2 and 2.2 per cent in 2011 and 2012. The overall recovery in GDP in both 2011 and 2012, the NIESR estimates, will be held back by fiscal retrenchment.

blanchflower chart

The chart above shows the most recent growth forecast by the Bank of England's Monetary Policy Committee (MPC), assuming that interest rates stay at 0.5 per cent through 2012. This does not include the additional £6bn of cuts the Tories propose to implement in 2010, which would lower growth even further.

The "fan chart" shows that, in any particular quarter of the forecast period, the MPC expects GDP to lie somewhere within the shaded area on 90 out of 100 occasions. The MPC's forecast shows that it is statistically plausible that GDP growth could be as low as 1 per cent in 2011.

But if interest rates were to rise above 0.5 per cent, as the market expects, this would lop off at least another half-point from growth, and lead to more cuts. Any increase in interest rates would hit hard the four and a half million households that are currently paying next to nothing on their tracker mortgages.

There remains the real possibility that the MPC and others are being much too optimistic and the actual outcome could be well below the green fan, if there are quarters of negative growth rates. Remember that the MPC and most other forecasters failed to call a recession even as late as August 2008, and have consistently been too bullish on growth since then. These forecasts depend on growth in net exports, especially from Europe, which is looking increasingly unlikely given the spreading sovereign debt crisis. And if households and companies become more uncertain about future macroeconomic prospects, their spending may be further constrained by the need to save more. And hence more cuts.

The paradox of thrift

Suppose that, for instance, growth was zero in 2011, which is not implausible. The absurdity of the argument that the way to deal with this is through fiscal tightening becomes clear. So the deficit rises and the government looks to save, say, £90bn, and education seems a prime candidate for the chop, with a billion left over. But it doesn't stop there, as we have now entered what Keynes called the "paradox of thrift". If households and firms are forced to reduce their spending, and the government, at the same time, cuts spending, unemployment will rise, because one person's spending is another's income, and the outcome will be less spending and less income all around. And down we go.

But there are alternatives. We could allow inflation to rise and reflate the debt away, or we could simply take a lot longer to pay off the costs of the economic war that we have had to fight over the past couple of years. Both are preferable to the death spiral we appear to be in danger of entering. All three leaders failed the economics exam.

David Blanchflower is the Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and professor of economics at theUniversity of Stirling

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire