EEconomic policy in the UK is peppered with S&M language. The Treasury demands budgetary discipline. The Bank of England sees the need for monetary tightening. Policy makers speak of the need to avoid “tax dominance”. Only in Britain could there have been an instrument of monetary control known as the corset.
Judging by the way the Treasury and the Bank behave, it’s easy to see why the novelist Anthony Burgess once called the English “deeply masochistic”. A great deal of self-inflicted pain is about to be administered, but for its victims there will be no pleasure involved.
Here is the current state of the nation. The economy is shrinking. National production is lower than it was at the start of the pandemic. Real estate prices have started to fall. Households have started to increase the amount they save for the tough times ahead. The standard of living is falling because wages are not keeping up with prices. Despite the price cap imposed by the government, average energy bills are double what they were a year ago. Officials are “playing war” on the possibility of week-long blackouts this winter. NHS England has more than 7 million people on its waiting lists. Food bank use is on the rise.
And what is the answer to that? Well, the Bank of England’s monetary policy committee is set to raise interest rates for an eighth straight meeting amid fears high inflation could trigger a wage-price spiral. The city expects a 0.75 percentage point increase to 3% and a signal from Threadneedle Street ahead. Bank knows what she’s doing will cause pain, but says it’s better than having even more pain later.
Yet there are none of the classic signs of the economy overheating. The Bank admits that pressures on the cost of living are mainly caused by global factors beyond its control, such as supply chain bottlenecks after the end of the Covid-19 lockdowns and the Russian invasion of Ukraine. The high level of job vacancies is not the result of excessively strong demand but because workers, mainly those aged 50 and over, have left the labor force. In these circumstances, raising interest rates is a particularly brutal instrument.
Meanwhile, the Chancellor, Jeremy Hunt, is preparing an autumn declaration on November 17 that will raise taxes and cut public spending. He has already told voters to be prepared for decisions of “breathtaking difficulty”. Hunt’s message is that Britain has been living beyond its means and a new era of austerity is needed to plug the black hole in state finances. Or, to put it another way, we’ve been mean and deserve to be punished.
If there really was a fiscal black hole it might be a good idea to fill it, but the idea that Britain is about to be sucked into a vortex because it runs a budget deficit is a fairy tale. A country that has its own currency, like the UK, can print money to cover its expenses. Although never admitted, the Bank of England’s quantitative easing – the large-scale buying of bonds – effectively financed public deficits during the global financial crisis and the pandemic. There is no black hole because the government cannot run out of money.
David Blanchflower, a member of the MPC during the global financial crisis, says the UK looks set to repeat the policy mistakes made then – and his warning is timely. In September 2008, a month before the Royal Bank of Scotland arrived hours after running out of cash, the Bank was considering raising interest rates because it feared inflation would set in. The real threat, as Blanchflower pointed out at the time, was that of a monstrous recession. Within months, official borrowing costs had been reduced by 5% to a then-record low of 0.5%.
The Treasure is living proof of the idea that insanity is doing the same thing over and expecting a different result. In 2010, as the economy began to recover from the crash, George Osborne decided the time was right to start tackling the budget deficit. Just like today, tax increases and spending cuts were seen as vital to keeping financial markets healthy.
An early criticism of Osbornomics came from Ed Balls in August 2010, when he was seeking to become the leader of the Labor Party. Yes, Balls said, there needed to be a credible plan to reduce the budget deficit and the national debt, but only when the economy had fully recovered. By doing too much, too soon, the coalition government was “undermining the very goals of market stability and deficit reduction that their policies are designed to achieve.”
Balls was making a direct Keynesian argument. JM Keynes did not believe in permanent budget deficits and believed, in good times, that government revenues should exceed government expenditures. But he was adamant that it was counterproductive to tighten policy during a recession, as happened during the Great Depression. It would make things worse in every way: slower growth, higher unemployment, and a bigger deficit.
The same applies now, but more so. Things are worse than 2010 because then the Bank of England kept borrowing costs down while the Treasury imposed its austerity programme. Currently, the Bank and the Treasury are tightening policy at the same time: a policy stance guaranteed to deepen and prolong the recession.
It’s not just that unemployment and poverty will increase. Capital spending cuts will mean more delays that will undermine the productivity of the country’s creaking infrastructure. The poor health that partly explains the absence of the over-50s from the labor force calls for more spending on the NHS. Taxes should be reduced to stimulate investment, targeting small and medium enterprises.
But while it should be obvious that greater austerity will make structural economic problems worse, the UK is firmly in the grip of a technocratic economic orthodoxy that insists that budgets must be balanced, the inflation under control and markets kept soft. The consensus among commentators is that there is no real alternative to what the Bank and Treasury are doing. Credibility is the priority.
This argument has already been made. It was used in 1925, when the consensus agreed that there was no alternative to putting the pound back on the gold standard. It was used in 1990, when the consensus was that there was no alternative to joining the exchange rate mechanism. Eventually, the “no win no win” approach was seen as lacking credibility and abandoned. But only after immense damage.