Salmon: Britain's Fiscal Failure

NEW YORK ( Reuters Blogs ) -- Never mind Sachs vs. Krugman : By far the most interesting and important fiscal-policy debate right now is Cameron vs. Wolf.

David Cameron, of course, is the prime minister of the UK, and last week he gave a rambling 4,000-word speech on the national economy that is almost impossible to read. For some reason the speech appears online in what you might call teleprompter format, with a single sentence sometimes spanning three separate paragraphs. It's a clear indication that Cameron is more interested in rhetoric than he is in substance.

Meanwhile, Martin Wolf, who for many years has been the most respected and important economic commentator in Europe, has in recent weeks become much more accessible. Check out his column on bankers' bonuses , for instance: It's a smart and rollicking read, arguing persuasively that the UK government is being idiotic in its opposition to European bonus caps.

Wolf's immediate response to Cameron was solid, but his second go-round is just devastating: We're now officially in a world where the wonkiest columnist in the driest newspaper in Britain is stating his case far more simply and clearly than the populist PR man turned prime minister:
Cameron argues that those who think the government can borrow more "think there's some magic money tree. Well, let me tell you a plain truth: there isn't." This is quite wrong. First, there is a money tree, called the Bank of England, which has created 375 billion pounds to finance its asset purchases. Second, like other solvent institutions, governments can borrow.

Wolf's main point is simple: In an economy that might already be in a triple-dip recession , deficits are caused by economic sluggishness. That's what forces up government spending while reducing government revenues. Everything comes back to growth: the UK credit rating, the size of the deficit, and, most simply, nominal GDP, which is now 13.6% lower than the government officially forecast it would be back in 2008.

What's more, government spending comprises a much larger share of GDP in the UK than it does in the US, which means that spending cuts can easily directly cause recessions. And deficits always go up, rather than down, in recessions:
The prime minister also stated: " Labour think that by borrowing more they would miraculously end up borrowing less ... Yes, it really is as incredible as that." What truly is incredible is that Mr Cameron cannot understand that, if an entity that spends close to half of gross domestic product retrenches as the private sector is also retrenching, the decline in overall output may be so large that its finances end up worse than when it started. Bradford DeLong of Berkeley and Larry Summers, the former U.S. Treasury secretary, have shown that, in a depressed economy , what Mr Cameron deems incredible is likely to be true.