The Daily Telegraph

Austerity takes a bath

The money tap is turned on as the obession with cutbacks fades

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Theresa May declared she was “ending austerity” last year. Her successors have taken the message on with vigour. Boris Johnson and Jeremy Hunt, vying to take over as prime minister, have both promised more spending hikes and tax cuts. The spending watchdog, the Office for Budget Responsibi­lity, has taken note and delivered three warnings.

Taken together these make it clear that the borrowing targets, the central plank of Conservati­ve economic policy for so many years, are in tatters.

The first warning is that, despite almost a decade of effort, the budget is not yet in balance. George Osborne and Philip Hammond made much of their plans to spend sensibly, and did indeed make progress.

The deficit fell from almost 10pc of GDP at its peak in 2009-10 to 1.1pc in the last financial year. But that still leaves borrowing of more than £20bn per year. The OBR sees it shrinking further, but not disappeari­ng.

The deficit is back at pre-crisis levels, but has not yet been vanquished.

All of that adds to the national debt that is still above 80pc of GDP, more than double its pre-crisis level.

“The current Chancellor has all but abandoned the Government’s legislated objective to balance the budget by the mid-2020s,” said the OBR in its fiscal risks report.

“And the £27bn a year NHS settlement announced in June 2018 – unfunded, unaccompan­ied by detailed plans for reform and outside the normal timetable for spending decisions – has cast doubts over the Treasury’s usually firm grip on department­al spending.”

With an ageing population pushing up health, social care and pension costs, the pressure is very much towards more borrowing.

The second is that Brexit could blow a hole even in these numbers.

Taking a “no-deal” scenario from the Internatio­nal Monetary Fund, which predicts a recession costing the UK 2pc of GDP by the end of 2020,

officials anticipate a £30bn surge in borrowing. That more than doubles the deficit, even before any additional measures are put in place to raise spending or cut taxes to boost the economy in the face of such a slump.

Third, whatever happens with Brexit or the current Chancellor’s plans, the next prime minister wants to borrow significan­tly more money.

“The remaining Conservati­ve leadership contenders have made a series of uncosted proposals for tax cuts and spending increases that would be likely to increase government borrowing by tens of billions of pounds if implemente­d,” said the OBR.

“So all the signs point to a fiscal loosening and less ambitious objectives for the management of the public finances.”

The Institute for Fiscal Studies estimates Hunt’s plans to cut corporatio­n tax would slice the tax take by as much as £13bn per year, while raising the National Insurance threshold would mean up to £11bn more staying in workers’ pockets instead of heading to the Treasury.

His defence spending plans would cost between £12bn and £40bn a year depending on which proposals he follows, while cutting the rate of interest on student loans would eventually end up costing around £1bn annually.

Johnson’s proposal to raise the threshold for the higher rate of income tax would mean the Exchequer missing out on £9bn per year. He has also mooted raising the NI threshold, at a cost of up to £11bn.

Big spenders

The pair are not alone in shifting to a new and seriously expansiona­ry fiscal policy.

Much of the world has tired of trying to keep a lid on debt. Expect bumper spending sprees in the years ahead.

The US is the leading example; a Republican Party that keenly sought to limit spending and debt in the years after the financial crisis is now spending and borrowing heavily.

The Congressio­nal Budget Office predicts a deficit this year of $900bn (£708bn) rising to more than $1 trillion in every year from 2022 until the end of its forecasts in 2029.

“We’re looking at the slow abandonmen­t of austerity,” says Christophe­r Jeffery, a strategist at Legal and General Investment Management.

“In Europe there has been slow progress, but there are signs of a rethink on the stability and growth pact. The new president of the European Commission, Ursula von der Leyen, is open to it.”

That is a view backed by Mark Wall, chief economist at Deutsche Bank, who anticipate­s “a more expansiona­ry use of fiscal policy to support the ECB in mitigating the coming recession”.

Von der Leyen’s role is critical, he believes: “She has sufficient standing in Germany to exert a positive influence on the discussion of German fiscal policy and to persuade the German public of the long-term wisdom of being financiall­y more supportive of the EU.”

That such financial institutio­ns anticipate more spending without sounding worried speaks volumes about the likely market reaction.

In the recent past, a key bulwark against excessive borrowing were the bond markets – the private investors who supply indebted government­s with their funds.

When borrowing levels were too high or spending plans deemed too risky, interest rates rose as investors required a higher rate of return to compensate them for the risk.

This was particular­ly powerful in the eurozone periphery as mounting debts and deficits caused panic in markets, forcing a degree of discipline on high-spending government­s. That effect now seems to have faded.

Partly it may be the result of central bank action. Mario Draghi at the ECB famously pledged to do “whatever it takes” to save the eurozone, buying as many bonds as needed to keep a lid on interest rates.

‘All the signs point to a fiscal loosening and less ambitious objectives for managing public finances’

A new dynamic

“Despite worries about the stability of its government and sky-high debt, Italy is able to refinance at an average rate of interest below 1pc. Greece pays only marginally more despite having suffered the world’s largest sovereign default in recent memory,” says Jeffery.

Draghi’s plan worked in the short run and may now have become a long-term effect.

Investors expect central banks to step up with more quantitati­ve easing whenever a slowdown threatens the economy, effectivel­y becoming a buyer of last resort for government­s.

That removes market discipline without central banks even needing to buy the bonds.

As a result there is little incentive for government­s to be cautious on public spending.

A new mentality is taking hold under which politician­s could seek to borrow and spend as much as they wish until inflation takes off, a developmen­t that will indicate the economy’s resources are becoming stretched, and central banks might stop buying their bonds, instead tightening policy to keep a lid on prices.

That is a whole new dynamic – and takes the world a very long way away from austerity indeed.

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