Most economists support the government’s plans to expand borrowing over and above the rise entailed by operation of the “automatic stabilisers”. However, a larger deficit does not necessarily imply a “fiscal stimulus”.

A standard economic principle is that most consumers base their level of spending on their income expectations over the long term rather than current earnings. Current income is a key factor only for those households with no savings or unable to obtain credit.

It follows that a temporary tax cut applied across all households and to be paid for by higher future taxes is unlikely to have a significant impact on consumption. Measures targeted at savings-short, credit-constrained households would have a greater chance of success but even in this case the rise in spending of those benefiting would be partly offset by cut-backs by other consumers anticipating lower future post-tax income.

This is not to say fiscal actions financed by higher borrowing can never deliver a short-term stimulus. However, policies must be designed to enhance the economy’s supply potential over the longer term, thereby warranting higher long-term income expectations. Examples include cuts in marginal tax rates, which stimulate entrepreneurship and effort, and public investment in projects promising a high long-term return (e.g. transport infrastructure).

A temporary cut in VAT fails the test of being targeted at households more likely to spend any windfall gain and has no positive impact on the economy’s long-term supply potential. Consumption of higher-value items will rise in the months before the lower rate is withdrawn but fall by exactly the same extent afterwards. The temporarily higher demand will be met either from imports or a rundown of stocks, with no impact on domestic production.

The longer-term “multiplier effect” of this VAT jiggling is likely to be close to zero.

Of course, higher borrowing may also have monetary effects – a rise in the deficit financed by bank borrowing would boost the money supply, thereby representing a “net injection of cash to the economy”. However, the same positive monetary impact could be achieved simply by underfunding the existing deficit, without a need for yet further fiscal “largesse”.