Economic policy in the UK is peppered with the language of S&M. The Treasury demands budgetary discipline. The Bank of England sees the need for monetary tightening. Policymakers talk of the need to avoid “fiscal dominance”. Only in Britain could there ever have been an instrument of monetary control known as the corset.
Judging by the way in which the Treasury and the Bank are behaving, it’s easy to see why the novelist Anthony Burgess once described the English as “profoundly masochistic”. A great deal of self-inflicted pain is about to be administered, but for its victims there will be no pleasure involved.
Here’s the current state of the nation. The economy is going backwards. National output is lower than it was at the start of the pandemic. Property prices have started to fall. Households have started to increase the amount they save in anticipation of hard times ahead. Living standards are falling because wages are not keeping up with prices. Despite the government’s price cap, average energy bills are double what they were a year ago. Officials are “war-gaming” the possibility of week-long energy blackouts this winter. NHS England has more than 7 million people on its waiting lists. Food bank usage is soaring.
And what’s the response to this? Well, the Bank of England’s monetary policy committee is about to raise interest rates for an eighth meeting in a row, because it is worried that high inflation will set off a wage-price spiral. The City expects a 0.75 percentage-point increase to 3%, and a signal from Threadneedle Street of more to come. The Bank knows what it is doing will cause pain, but says that’s better than even more pain later.
Yet there are none of the classic signs of the economy overheating. The Bank admits that cost of living pressures are mainly caused by global factors outside its control, such as supply chain bottlenecks after the end of Covid-19 lockdowns and Russia’s 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 above, have left the labour force. In those circumstances, raising interest rates is a particularly blunt instrument.
Meanwhile, the chancellor, Jeremy Hunt, is preparing an autumn statement on 17 November that will raise taxes and cut public spending. He has already told voters to brace themselves for decisions of “eye-watering” difficulty. Hunt’s message is that Britain has been living beyond its means, and that a new era of austerity is needed to fill the black hole in the state’s finances. Or, to put it another way, we’ve been naughty and deserve to be punished.
If there was really such a thing as a fiscal black hole, it might be a good idea to fill it, but the idea that Britain is about to sucked into a vortex because it is running a budget deficit is a fairytale. A country that has its own currency, as the UK does, can print money to cover its spending. While it is never admitted, the Bank of England’s quantitative easing – large-scale buying of bonds – effectively funded government deficits during both the global financial crisis and the pandemic. There is no black hole because there is no way the government can ever 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 back then – and his warning is timely. In September 2008, a month before Royal Bank of Scotland came within hours of running out of cash, the Bank was considering raising interest rates because it feared inflation would become embedded. The real threat, as Blanchflower pointed out at the time, was of a monster recession. Within months, official borrowing costs had been cut from 5% to a then record low of 0.5%.
The Treasury is living proof of the notion that insanity is doing the same thing over again and expecting a different result. In 2010, just as the economy was starting to recover from the crash, George Osborne decided that the time was right to start hacking away at the budget deficit. Just as today, tax increases and spending cuts were deemed vital to keep the financial markets sweet.
An early critique of Osbornomics came from Ed Balls in August 2010, when he was pitching to become leader of the Labour 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 which their policies are designed to achieve.”
Balls was making a straightforward Keynesian argument. JM Keynes did not believe in permanent budget deficits, and thought in good times that the state’s income should exceed its spending. But he was adamant that it was self-defeating to tighten policy during a downturn, as happened during the Great Depression. Doing so would make matters worse in every respect: slower growth, higher unemployment and a bigger deficit.
The same applies now, only more so. Things are worse than in 2010 because then, the Bank of England kept borrowing costs at rock-bottom levels while the Treasury imposed its austerity programme. Currently, both the Bank and the Treasury are tightening policy at the same time: a policy stance guaranteed to make the recession deeper and longer.
It is not just that unemployment and poverty will rise. Cuts to capital spending will mean more productivity-sapping delays on the country’s creaking infrastructure. The ill health that explains some of the absence of the over-50s from the labour force calls for more spending on the NHS. There is a case for lower taxes to stimulate investment, targeted at small and medium-sized businesses.
But even though it should be obvious that more austerity will make structural economic problems worse, the UK is firmly in the grip of a technocratic, economic orthodoxy that insists budgets must be balanced, inflation tamed and markets kept sweet. The consensus among the commentariat is that there is no real alternative to what the Bank and the Treasury are doing. Credibility is the priority.
This argument has been deployed before. It was used in 1925, when the consensus agreed 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 gain without pain” approach was seen to lack credibility, and abandoned. But only after immense damage was done.
Larry Elliott is the Guardian’s economics editor
