How will Britain dig itself out of a £300bn coronavirus hole?
Millions of workers in Britain have been furloughed but the UK Debt Management Office (DMO) has never been busier. The government body responsible for selling gilts – government bonds – is working flat out to cover the burgeoning gap between what the state spends and what it raises in taxes.
So far, so good, as far as the DMO is concerned. Investor appetite for gilts is healthy: the markets bought £12bn of 10-year bonds on Tuesday and another £2.25bn of 20-year bonds on Thursday.
That sort of busy schedule will continue. The Covid-19 pandemic is forcing Britain into a recession unprecedented in modern times, and ending the lockdown of the economy is proving difficult.
It appears inevitable that government borrowing will hit a peacetime record this year. The Office for Budget Responsibility – which makes fairly optimistic assumptions about the speed at which activity will bounce back – still thinks Rishi Sunak will need to borrow nearly £300bn to balance the books. At around 15% of national income, that would dwarf the borrowing peak of the last recession a decade ago.
If the economy takes longer to recover, the figure could be even higher, topping £500bn in worst-case treasury estimates. Lord Robert Skidelsky, the biographer of John Maynard Keynes, says there is a risk of an inflationary depression, with the supply capacity of the economy badly affected by the crisis but spending power protected by wage subsidies.
Inevitably, there is already debate about what needs to be done to bring the deficit back to more normal levels.
Gerard Lyons, senior fellow at the thinktank Policy Exchange and economic adviser to Boris Johnson when he was mayor of London, says it would be a mistake to repeat the austerity programme introduced by George Osborne when the coalition government took power in 2010.
“The idea should be to reduce the
deficit over time through a pro-growth strategy,” Lyons says. “A rising budget deficit acts as a shock absorber during this crisis and we should be grateful for it.”
Lyons adds that the government should avoid cutting spending or raising taxes. Instead, the Bank of England should tailor its activities in the gilts market to make it possible for the government to continue borrowing cheaply.
The Bank could do this, Lyons says, by buying gilts that mature years into the future. Doing so reduces the interest rate – or yield – on long-term borrowing.
David Davis, the former Brexit secretary, agrees that the approach should be to pay off the debt accumulated during the crisis over time. “I would be happy to see it paid off over 50 years,” he says, adding that there is no appetite in the Conservative party for a repeat of Osborne’s austerity regime.
“I think the way forward is one part [Franklin] Roosevelt’s new deal, one part Ronald Reagan’s deficit financing, and one part a new Bretton Woods to get international trade going again.
Austerity would launch the economy into so many brick walls it would be hard to list them all. It’s a bonkers idea.”
Osborne’s view that the deficit had to be tackled head-on was motivated by fear that investors would take fright at the state of Britain’s public finances and demand higher interest rates for holding government debt.
There is a different mood today. First, there is no sign of gilt yields being driven up by nervous investors. Despite every developed country being obliged to borrow more money, bond yields have never been lower. The International Monetary Fund has told countries to spend as much as they can.
Second, there are fears of a repeat of the 2010 experience, when too much austerity too soon killed off recovery in its infancy. Mervyn King, who as governor of the Bank of England encouraged Osborne to take a tough line on the deficit, said this week that Sunak should continue with the furlough scheme until recovery was well established.
Finally, the government knows austerity would be politically problematic and so is looking for other solutions. Sunak is unlikely to order the Bank simply to print the money to finance his spending, but instead will hope stronger growth, a bit of inflation, a higher tolerance for debt among investors and time will dig him out of the hole.