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Plan B: Reduce NI contributions

Dear Chancellor,

I was very pleased to hear in your speech to the Tory party conference that you are planning to start credit easing, as I suggested that you do in my NS column of 9 September. My good friend Adam Posen of the Monetary Policy Committee has also set out the case for doing so.

It is of grave concern that small firms are struggling to obtain credit and that Project Merlin (the agreement between banks and the government) has clearly not delivered, but it should be said that it never seemed likely it would. It didn't help that there were no penalties for failure, as there should have been. The research evidence is that credit constraints have a severe impact on a small firm's ability to grow, and reducing them can have substantial positive effects. The concern, however, is that you do not appear to have worked out how to do this yet and we are going to have to wait until Nov­ember to find out what your plans are. Sadly, you really did mean you had no Plan B.

Unfortunately, all of this may be too little, too late, because there is a long time lag between the announcement of a plan and it taking effect. The revisions to growth announced by the Office for National Statistics in the first week of this month have changed everything. It is now clear that the recession was considerably deeper than previously thought: output fell by 7.2 per cent (revised down from 6.6 per cent). It seems it was a major mistake to impose austerity with no plan for growth, in the depths of what Mervyn King called "the most serious financial crisis . . . since the 1930s, if not ever". Up to this point, only about a third of lost output has been restored and none for the past three quarters. It is time to slow the spending cuts.

It hasn't helped that you described the economy as "bankrupt" when clearly it was not, and also compared the British economy with that of Greece, Ireland, Portugal and Spain, which are locked in monetary union, do not have their own central bank and cannot depreciate their currency or engage in credit easing. With such unpatriotic talk, you and other coalition leaders have caused business and consumer confidence, and thus consumer spending, to collapse. They are at frighteningly low levels and I suspect they will fall a lot further unless you act quickly.

My first piece of advice is to stop drawing false comparisons. It is time to talk the economy up rather than talk it into recession as you have been doing. Keynes was right: animal spirits matter, and you have lowered them. Stop it.

It certainly appears that increasing VAT from 17.5 per cent to 20 per cent was a big mistake - it increased measured Consumer Prices Index inflation by 1.5 percentage points and hit ordinary working people's living standards. It made the MPC's job a lot harder, and I suspect without it the committee would have moved to QE much sooner. It is time to reverse that VAT increase.

My final and most important piece of advice concerns the young, who need help - and soon. The number of unemployed young people under the age of 25 is about to break through the million mark and there is a growing danger that they will become a lost generation.

So I suggest you increase the number of university places by 100,000 at once - the universities have the capacity. You could even insist that the extra places be primarily in science and engineering, which would help future growth. Second, give a tax holiday for two years on employer and employee National Insurance contributions for anyone under the age of 25. This would stimulate the economy and price young people into work, and probably pay for itself.

You must loosen fiscal policy and slow the pace of public spending cuts or you will push the UK economy over the precipice. The Bank of England cannot take the strain on its own.

David Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College , New Hampshire and the NS's economics editor. He served on the Bank of England's Monetary Policy Committee from 2006 to 2009

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

This article first appeared in the 17 October 2011 issue of the New Statesman, This is plan B