We’ve been here before. The Chancellor wants to make “fiscal discipline” a “key dividing line” with Labour at the next election. If so, he’s learned the wrong lesson from George Osborne—putting the political interests of the Conservative Party ahead of the needs of the economy. Osborne’s strategy was successful, on its own terms, as the 2015 election showed. But his principal legacy was the hollowing out of large parts of the public sector, especially social services and local councils, and a woefully inadequate benefits system. Far from “fixing the roof while the sun is shining,” austerity made us more vulnerable to the pandemic.
Meanwhile, the consensus amongst economists (although many of us were making these arguments at the time) and, more importantly, international financial institutions and policymakers has shifted radically. The IMF’s Chief Economist recently issued both a mea culpa and a warning: “There is consensus that fiscal stimulation was withdrawn too quickly right after the financial crisis. And that is a mistake that we want to avoid happening again—it is important not to prematurely withdraw policy support.” When Laura Kuenssberg says “there is really no money” or talks about the national “credit card” being “maxed out,” she is talking nonsense on stilts.
The Biden Administration, with many of the key players having been burnt by Obama’s timidity, has taken this to heart. Even though the US economy has been less badly hit by the pandemic than either the UK or large EU economies, it is proposing a support package, including direct payments to households, much more generous child benefits, and aid to state and local governments, of about 9 per cent of GDP. This is on top of a deficit already projected at 10 per cent of GDP, and despite the fact that conventional estimates of the “output gap”—the amount of potential slack in the economy—are far smaller in the US.
The US is undertaking a vast macroeconomic experiment. Standard models used by governments and central banks—and the UK’s Office for Budget Responsibility—predict that the impact of this sort of action will be to pump up demand, resulting in a consumer-led boom followed by higher inflation, higher interest rates, and an inevitable reversal, if not recession. Those same standard models tell us that the UK, even assuming a relatively strong recovery, faces a substantial structural deficit—perhaps £70bn, or 3 to 4 per cent of GDP, according to the IFS—and that large tax increases will likely be required, if not now then over the next few years.
Indeed, if, as the Bank of England’s Andy Haldane argues, the UK economy is like a “coiled spring,” with better-off households poised to spend the very large savings they have built up during the pandemic, then inflation and higher interest rates may be nearer than we think. In such circumstances, taxes should go up sooner rather than later.
So what should the Chancellor do in his March Budget? In practice, he is unlikely to repeat Osborne’s error of front-loaded fiscal consolidation, and certainly not his VAT hike. More likely is an exercise in signalling: a combination of modest tax rises on businesses in the short-run with a variety of reviews and announcements pointing at more substantial tax rises and, perhaps, spending cuts down the line, as well as a rhetorical commitment to balancing the budget.
This is not an obviously flawed strategy. In the short term, increased corporation taxes only hit profitable businesses, and will do little to dampen demand. The Chancellor should certainly consider a windfall or excess profits tax on Amazon and other companies that pay absurdly low taxes while benefiting hugely from the UK market. Indeed, it’s a measure of how far our thinking has shifted that this approach of delayed fiscal consolidation is pretty much what I and similarly inclined economists would have recommended in 2010-11.
But beyond simply ignoring deficit scaremongering, I think we should learn another lesson, about uncertainty, resilience and the balance of risks. I was brought up on the standard models that tell us the Biden stimulus is too big, and we need to think about raising taxes here; but there’s little in those models that explains the persistently low interest rates and inflation and weak growth of the last decade. Can “running the economy hot” generate extra growth, and perhaps faster productivity growth and higher wages, without sharply rising inflation?
We shouldn’t be afraid to admit that we can’t be certain about the answer. But we can say something about risk. If we raise taxes and cut the deficit too slowly, waiting until it’s absolutely clear inflation is taking off, we may end up with a worse fiscal position, higher inflation and interest rates than is necessary, and be forced to put up taxes anyway. That would be a policy error, but not a disastrous one. Alternatively, if we consolidate too quickly, the risk is another decade like the last one, of stagnant productivity and underfunded public services, and lost growth that will never be recovered.
The aftermath of the pandemic presents an opportunity, both political and economic. The government can and should spend what is needed to restore our public services and address the legacy of poverty and deprivation left by the past decade, compounded by the pandemic; and at the same time finance its commendable ambitions to “level up” and decarbonise the economy. When and if this spending results in persistently higher inflation, then higher interest rates and tax rises will indeed be necessary. This is a gamble we can afford to take.
