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Fiscal stimulus doesn't work, claims Harvard economics professor Robert Barro

Keynesian-style fiscal stimulus programmes do not work, leading Harvard economist Robert Barro has warned, adding that large spending plans should be undertaken only if they can be justified financially on their own merits.

By Philip Aldrick

6:00AM BST 06 Jul 2011

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Breaking with current economic orthodoxy, Robert Barro, Paul M Warburg Professor of Economics at Harvard University, said large spending plans should be undertaken only if they can be justified financially on their own merits. Any other spending plans end up costing the country even more than the initial outlay as interest on the debt has to be paid and the deficit cleared.

"In the long run you have got to pay for it. The medium and long-run effect is definitely negative. You can't just keep borrowing forever. Eventually taxes are going to be higher, and that has a negative effect," he said.

"The lesson is you want government spending only if the programmes are really worth it in terms of the usual rate of return calculations. The usual kind of calculation, not some Keynesian thing. The fact that it really is worth it to have highways and education. Classic public finance, that's not macroeconomics."

Turning to the $600bn (£373bn) to $800bn US package, he added it was "mainly a waste of money". Stimulus programmes, he said, offer little more than "rearranging the timing" of economic growth. "Possibly you could make an argument that it's worth it. But it's going to be a negative-sum thing overall, so you have to think it's a big benefit for boosting the recovery."

His comments, made to The Telegraph ahead of delivering the Institute of Economic Affairs Annual Hayek Memorial Lecture sponsored by CQS, are likely to stoke the debate over the flagging British recovery.

The Coalition is sticking to its guns with plans to eliminate the structural deficit by 2015, while Labour is proposing a more gentle approach of halving the deficit in the same time. Ed Balls, the shadow Chancellor, has also called for a temporary reduction in VAT to help simulate the economy.

Mr Barro argued that, taken over the long term, for every £1 spent, the cost to the economy will be more than £1 – creating what he called a negative fiscal multiplier. Orthodox thinking is that current stimulus programmes have a positive multiplier effect by creating growth.

He acknowledged, however, that there are times when stimulus programmes are needed – such as in the recent recession. But he said they should be delivered through necessary capital projects and tax cuts, to deliver required services and make the economy more efficient.

Turning to quantitative easing, he warned that the US and UK are storing up inflation and that the Bank of England may be too complacent. Although there is no threat to inflation now, he said: "You have to have an exit strategy. Ben Bernanke [chairman of the US Federal Reserve] and [bank Governor] Mervyn King are aware of this, but I think they are a little over confident about how they can accomplish it. Because you want to have this exit strategy without having a lot of inflation.

"That's when the inflation would occur. If there's a recovery and there's all this liquidity and somehow the central bank has to reverse it."

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