© Phil Noble/ReutersDavid Cameron is to urge the public to pay off its credit card and store card debts.
To our ears that sounds both callous and wrong. But that's partly hindsight - Mellon was speaking before Keynes wrote The General Theory of Employment, Interest and Money. David Cameron has no such excuse. He is set to tell us today in his conference speech that "the only way out of a debt crisis is to deal with your debts. That means households - all of us - paying off the credit card and store card bills".
But with fiscal policy set on what Martin Wolf has rightly described in the Financial Times as "kamikaze tightening", the UK needs the private sector to pick up the slack. If all sectors - the government, firms and households - increase saving simultaneously, in an effort to reduce debt, it will further depress domestic demand, reduce output and jobs, and we will end up in a downward spiral. This is what Keynes described as the paradox of thrift.
That is why all the main economic forecasters - the Office for Budget Responsibility (OBR), the Bank of England, and us here at the National Institute of Economic and Social Research - have made clear that the main domestic risk facing the UK economy is that household and corporate saving will be too high in the short term; in other words, that we do indeed "deal with our debts".
Indeed, the main difference between our more pessimistic outlook and the OBR's more optimistic perspective is that we assume household saving is rather higher. In other words, the government's economic and fiscal forecasts depend crucially on households ignoring what the prime minister is telling them to do.
And this downside risk - that everyone tries to pay off their debts at the same time - is precisely why I and others, like Martin Wolf and Paul Krugman, have long been arguing that fiscal policy is too tight. As Richard Koo of Nomura Research Institute, who invented the term "balance sheet recession", puts it, "the point is that if you are in this type of recession, which happens only after the busting of a nationwide asset bubble financed by debt, the private sector decides to minimise debt rather than maximise profits. If the government doesn't take the action to keep the situation from collapsing, then you have larger problems going forward."
Even the chancellor seems finally to get this. Earlier this week he came up with a policy, borrowed from Adam Posen at the Bank of England, which he described as "credit easing", but is really about more borrowing. He wants the Treasury to borrow more, and to lend the money on to private businesses who would therefore also be borrowing more. More debt all round - and quite right too. Other policies are needed as well, but it's a welcome start.
But the prime minister is arguing in precisely the opposite direction - for an increase in private saving at the same time as a tightening of fiscal policy - less debt, and a reduction in demand all round.
This is truly a return to the economic thinking of the 1920s; if anyone actually listened, it would be a disaster. We would indeed purge the "rottenness" of excessive debt out of the system, as Mellon would have put it, at the expense of any hope of sustained growth. A return to recession would no longer be a risk but a certainty.
Update: 13.21
Since this piece was published, the prime minister's aides have said his speech will be rewritten.
It is moderately reassuring that the prime minister, or his advisers, have realised that the original text of his speech - calling for us to pay off all our debts - would, if followed, lead to economic disaster. Apparently, he is now going to say "That's why [excessive debt] households are paying down their credit card and store card bills."
This has the merit of being true. But he fails to draw the obvious and logical conclusion; that if the private sector is indeed spending less and saving more, because of the burden of debt, then the public sector needs to step in to support demand. Instead the government is doing the exact opposite and cutting spending too fast, risking a further downward spiral.
So while the speech no longer includes the original mistake, it relies on the same underlying faulty analysis. If all sectors - government, households and firms - all increase saving and reduce spending at once, the inevitable consequence will be a severe reduction in overall demand and hence a return to recession. So the imperative is for government to take action to make sure that doesn't happen - not to make matters worse.
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