The return of the 'deficit deniers'?

Many in the government were surprised at their own success last year, in building a political consensus in favour of their budget cuts. Wise heads knew that the mood would shift, when the cuts actually came in. But thanks to one set of bad GDP figures, the ground may be shifting even earlier, and faster, than they thought.

I wrote last week how that first estimate of growth - or the lack of it - put George Osborne and the Prime Minister on the back foot in Davos. By the same token, the new shadow chancellor Ed Balls could not have picked a better week to take over the job. He has - famously - had to revise his position on Alistair Darling's planned deficit cuts (the formulation is tortuous, but that's the gist). But he's still the British politician who has made the most detailed intellectual case against the cuts, in his campaign for the Labour leadership last summer.

The shadow chancellor will feel he has had further reinforcement in the past 24 hours, from the National Institute for Economic and Social Research and from Larry Summers, the economist who has recently stepped down as President Obama's chief economic advisor.

The NIESR this morning slightly lowered their UK growth forecast for 2011 from 1.6% to 1.5%, and the 2012 forecast from 2% to 1.8%. These compare with the official OBR forecasts of 2.1% growth in 2011 and 2.6% in 2012. At the press conference launching its new report, the institute's acting director, Ray Barrell asserted, without qualification, that "fiscal policy is too tight this year". The report itself has this to say:

"There is no doubt that a fiscal consolidation plan should be in place, and we have argued for one both before and after the election. Increasing the national debt transfers resources from our children to us, and leaves us unprepared for the next crisis. However, the debate over the timing and scale of the consolidation is not over. Borrowing is cheap, debt default risks in the UK are low, and there is a significant output gap in the economy. In these circumstances we would argue for a delay in consolidation."

It will be interesting to see how many city economists lower their forecasts in the coming weeks, as a result of last week's GDP figures for the fourth quarter of 2010. If you think the figure is a genuine blip - a freak result of the weather which will be recouped in the next few months - then you're not necessarily going to lower your forecast. Indeed, the percentage growth for 2011 could even go up, if forecasters take the view that the output lost in 2010 will happen in 2011 instead. But if forecasters look through the effects of the snow and see a serious loss of economic momentum, the forecast for 2011 and even 2012 will surely go down.

I suspect many will wait to see the first estimate for growth in the first quarter, before making a definitive judgment either way. Alas, this is not open to the chancellor, who must deliver his budget on 23 March, more than a month before that first quarter figure comes out.

If you heard my interview on the Today programme this morning (0840) you'll know that Larry Summers declined to make any strong predictions about the UK. He stuck to the content-free formulation that he expected markets to "fluctuate". (Similarly, Bob Rubin, when he was US Treasury Secretary, used to say "markets go up, markets go down.) But Summers allowed more content to slip into his assessment of the government's case for rapid budget cuts.

In normal times, he said, it is right to argue - as the government implicitly does - that fiscal policy does not affect the overall amount of activity in an economy, only the division between public sector spending and investment, and private. At such normal times, it is the monetary policy of the central bank that largely dictates the short-term path for growth.

But, he said baldly, these are not normal times. In his view, we are in - or close to - what J M Keynes called a "liquidity trap", in which there is a near infinite demand for liquid assets, and monetary policy is largely ineffective, because interest rates cannot fall any lower, and businesses and consumers want to save, not spend. In these extra-ordinary circumstances, he thinks that the usual rules do not apply, and fiscal policy has to step up to the plate to support demand.

The implication is that the coalition is indeed taking a risk with the recovery, and putting their deficit targets at risk as well. Because, if Summers is right, the private sector may well not come to the economy's rescue: growth will be lower than forecast - and borrowing is likely to be higher.

You might say - who cares what Larry Summers thinks? We all know that the US can get away with borrowing a lot more than the UK can. We also know that Summers is a Democrat, who taught Ed Balls when he was a Professor at Harvard. (I should add, I worked for Summers when he was US Treasury Secretary in the late 1990s.)

But, Summers is no left-wing firebrand. Far from it. Many on the left of his party can't stand his pro-business, pro-market approach. Indeed, many say his zeal in liberalising the US financial markets helped pave the way for the crisis of 2008-9. For most of the time he was Treasury Secretary, the US was running a surplus, not a deficit.

As Summers is the first to admit, the right fiscal strategy for the UK right now is a matter of precise judgment, which he, as an outsider, is not well placed to make. But at the heart of that judgment is the issue he raised in his interview: is this going to be a "normal" recovery? Or has a once-in-a-century financial crisis thrown the usual rules of macroeconomic policy up in the air?

For the moment, the governor of the Bank of England, the Treasury, the OECD, the IMF and, probably, the majority of economic forecasters in the city all believe the usual rules do apply. True, they would argue, we might not be looking at a strong recovery, but that's the price we pay for a long and unsustainable boom, and a massive increase in the amount of public and private debt. Fiscal tightening carries a risk, but continuing to spend and borrow at this rate would be riskier still, and quite likely counterproductive as well.

The likes of Martin Wolf at the FT and the nobel prize winner, Paul Krugman, have stood against this consensus for some time. I mentioned earlier that it would be interesting to see how many economists change their forecasts as a result of last week's figures - particularly if we see other disappointing numbers in the weeks ahead. It will be even more interesting to see how many change their tune on the pace of cuts.