If you are wondering why the economic background is so dire, the answer is simple: too much debt. Over the last 30 years, Western economies have relied on an increasing amount of debt to generate economic growth. For instance total economy debt (i.e. private sector and government) to GDP in the UK has risen from 160% in 1980 to 322% in 2010. This is actually understated as it doesn’t include debt associated with PFI and public sector pension liabilities.
It’s not just the UK, all the major Western economies have seen the same trend, although with different combinations of private and public sector debt. We are now at a point where debt has become toxic to growth. Hence, the Ed Balls “Plan B” won’t work. The conundrum is that growth will be weak whether fiscal consolidation is fast or slow. If it is slow, then a crisis of confidence in debt markets (as we have seen for Greece) is possible. So it is better to gain credibility with the coalition plans and hopefully head off a crisis.
Why am I telling you this? Well, forearmed is forewarned and we are headed into a very difficult period with a probable eurozone breakup and another recession more than likely. Get your finances in order, because the banks are running scared and access to credit will become even more difficult over the next two years.
If you want some more detail on rising debt in the West, there’s an excellent research paper from the Bank for International Settlements. You only need to read the first few pages to get the gist. The table below is an extract from it.