Jeremy Hunt has taken a wrecking ball to the British economy
Jeremy Hunt’s Autumn Statement has presented us with big tax rises and spending cuts in order to avoid a large “fiscal hole” created by the need to have the debt-to-GDP ratio falling by 2027-28 – the new “fiscal rule”. But it will worsen the recession and, ironically, will also wreck the public finances.
Government borrowing is an important policy instrument that permits a government to do two beneficial things: first, to keep tax rates stable at levels fit for long-term growth, and, second, to allow for swings in the budget balance to mitigate the business cycle. The government must also balance its books over the long run, as ours has always done for the past two centuries. But the words “long run” are vital. They mean that, looking ahead, the government’s debt must always be reliably serviceable.
In practice, we can test this by making long-term projections, typically 10 years ahead at least, to check that the debt/GDP ratio is coming down to a level such as 50 per cent, where it poses no problem of sustainability. Now, turn to Thursday’s Statement to see how the Government got into this mess. Why has 2027-28 been picked as the year when the debt ratio must be falling?
This choice is both too strong and too weak. Too strong because it is preventing the flexibility needed for the two functions identified above. Tax rates essential to supporting growth, notably corporation tax, are being sacrificed to it. Also, a bad looming recession, which the Government should mitigate, will be, on the contrary, worsened by a pro-cyclical fiscal tightening. So, this Statement will worsen the recession and damage growth.
But this date choice is also too weak, because it does not reassure us about long-term debt sustainability. Indeed, because growth will be damaged, the UK’s long-term debt/GDP ratio will be badly worsened. According to our Cardiff models, which have been fitted to the UK data and so are more pessimistic than the Office for Budget Responsibility about the effects of tax rises, growth will be reduced to zero. Then, if anything like the current spending plans are maintained, the debt/GDP ratio will spiral upwards towards dangerous levels.
Such projections reveal the importance of growth not merely to our citizens’ living standards but also to our Government’s financial health.
Yet had the OBR done its arithmetic on alternative tax policies that did not damage growth, then according to our Cardiff models, growth would get back on its 2 per cent per annum 30-year trend up to the pandemic. Then, the OBR would find that the debt/GDP ratio would trend safely downwards over the next decade.
So, this quite arbitrary fiscal rule means that the Statement wrecks not just the economy, but also the longterm public finances. This is the fundamental flaw in its whole approach.
There is also a particular error in the OBR’s arithmetic that badly increases the pessimism of its debt projections. This concerns the cost of the Bank of England’s quantitative easing (QE) programme, whereby the Bank has bought Government bonds and other market assets by printing money in the form of bank reserves.
The Treasury/OBR accounting treats bank reserves as debt, with interest levied at Bank rate. But this is expensive nonsense; bank reserves can only be swapped for cash, which has a storage cost and pays no interest. The Bank has no need to pay interest on bank reserves to control the cost of credit. It has a toolbox it can deploy to determine this, including setting reserve ratios and lending directly into the markets.
This Bank practice did not cost the state anything much when bank reserves were small – as was the case before the financial and Covid crises, or when interest rates were close to zero. But bank reserves are now huge after all that QE, at £950 billion; and with 3 per cent interest rates, the interest cost is now nearly £30billion a year.
This is a totally unnecessary addition to the Government’s costs. It is equivalent to paying commercial banks a windfall subsidy equal to the shortterm interest rate, with no justification. Disregarding Bank debt sales, this error cumulatively raises the OBR debt/GDP ratio by nearly 10 per cent of GDP by 2027, and the OBR “fiscal hole” in 2027-28 by about £50 billion.
Finally, we come to the strategic reason given for this Austerity 2.0: to reassure the bond markets on two counts – that we pose no solvency risk and that UK inflation is under strong control. Both are misconceived.
Our credit default swap rate has remained moderate, even at the height of hysteria over the previous Liz Truss plan. As for the current inflation, it is largely the result of commodity supply shocks that are being steadily reversed, as supply bottlenecks are eased. US inflation is now past its peak and ours is close to it; the bond market’s fears of inflation are much subdued, so would pose no threat to a Statement that supported the economy instead of trashing it like this one.
The monetary causes of inflation – excessive money-printing during Covid – have now been not just reversed but pushed into monetary overkill, with annual money supply growth close to zero across the US, the EU and the UK. Forecasts of inflation for 2023 are now for about 5 per cent in most developed economies. The Chancellor’s announcements will make no difference to commodity prices. But they will worsen wage inflation by reducing people’s take-home pay. Moreover, they worsen long-run solvency by reducing growth.
In short, the Autumn Statement is a wrecking ball – worsening recession, damaging growth, degrading the long-run public finances and even raising inflationary wage costs. Commons amendments are needed to restore sanity to these plans.
His Autumn Statement will end up worsening the recession and damaging the public finances