Government deludes itself that it can steer the economy
In 1969, the British financial journalist Samuel Brittan published a book called Steering the Economy: The Role of the Treasury. It was still assumed that the United Kingdom’s economy was steerable and that the Treasury (which was still in charge of monetary policy) was at the helm.
Back then, the Treasury’s macroeconomic model, which calculated national income as the sum of consumption, investment and government spending, effectively made the budget the regulator of economic performance. By varying spending and taxation, the Treasury could nudge the UK toward full employment, GDP growth and low inflation.
Subsequent models, influenced by the monetarist and New Classical revolutions in economic theory, have reduced the state’s capacity to intervene. Yet the belief that governments are responsible for economic performance still runs deep.
The UK’s recent budget announcement is a case in point. Chancellor of the Exchequer Jeremy Hunt sought to reassure MPs that the government is on track to tame inflation, reduce debt and boost economic growth.
As he put it: “We are following the plan, and the plan is working.”
Yet it has long been clear that inflation and growth depend on global trends over which the British chancellor has no control.
The fact is that international finance, technology and geopolitics rule out any possibility of “steering” the UK economy. While these variables were regarded as predictable as late as the 1990s, today all three are considered a source of exogenous shocks.
No UK policymaker, for example, predicted the global financial meltdown caused by the 2008 collapse of Lehman Brothers. Likewise, no one can foresee the repercussions of the recent failure of Silicon Valley Bank and Credit Suisse.
And with heightened geopolitical tensions threatening global supply chains, the models on which policymakers like Hunt rely are becoming increasingly obsolete.
Specifically, the relationship between fiscal and monetary policy is veiled in mystery. The reigning economic model assumes that controlling inflation is a sufficient condition for macroeconomic stability, and that inflation is primarily caused by budget deficits, or “governments printing too much money”.
With that in mind, the government outsourced the task of steering the economy to the Bank of England in 1997, while the Treasury remained in charge of balancing the budget and reducing net debt.
The combination of BOE independence and fiscal discipline was supposed to assure markets that politicians would not go on spending sprees.
But, given that the BOE has been printing as much money as politicians want since the start of the Covid-19 pandemic, the separation between fiscal and monetary policy has become largely fictional, along with the stability and prosperity it was said to ensure.
Hunt should have looked to US President Joe Biden for more creative economic thinking. Biden’s Inflation Reduction Act, which includes $370-billion in clean-energy subsidies, is based on an almost forgotten macroeconomic idea known as the balanced-budget multiplier: higher public spending can be paid for by raising taxes on the rich.
Biden’s stated policy is still to balance the budget, but this approach would enable him to do so while boosting spending, rather than adopting the sort of austerity policies that UK governments continue to pursue.
Biden’s policy represents a welcome return to the old Keynesian view that aggregate demand matters. By contrast, Hunt’s plan to boost growth depends entirely on remedying structural (or supply-side) deficiencies.
The UK’s puzzling labour shortage underscores the inadequacy of the British government’s approach. The number of unemployed people is 1.3 million, yet many businesses are struggling to find workers, with job vacancies jumping to 1.1 million.
Hunt’s answer is to increase incentives for the “economically inactive” to rejoin the labour market. But, in practice, he is encouraging people to apply for jobs that do not exist. The reason is that despite supply bottlenecks in sectors such as retail, hospitality and agriculture, the economy as a whole is experiencing a deficiency of aggregate demand.
Given that the British economy has still not recovered to its 2019 level, this should not come as a surprise. Yet the government’s latest budget makes no mention of boosting aggregate demand for labour.
In late 2020, former UK prime minister Gordon Brown and I proposed a scheme whereby the government would guarantee a job or training at a fixed rate not less than the minimum wage to anyone who could not find work. This, we argued, would be the quickest way to boost aggregate consumption. As John Maynard Keynes once said: “Look after unemployment, and the budget will look after itself.”
At a time of global turmoil, the budget’s primary purpose is not to steer the economy to the point of imagined stability. Rather, policymakers must use fiscal policy to protect the least well-off from external blows and to achieve maximum strategic autonomy in a world that is spinning out of control.