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Yesterday was budget day in the UK. Read the FT’s excellent coverage here, including Chris Giles’s review and Martin Wolf’s commentary. The only contribution I want to sneak into all of this good reporting is to observe how the UK’s budgetary choices compare to common challenges in an international context.
As I have already warned, the debate on scarcity, inflation and overheating does not pay enough attention to the fact that we are entering a period of record-breaking fiscal tightening. Just as the exceptional deficit spending supported incomes and therefore economic activity during the pandemic (all activities that were allowed to continue), the withdrawal of this support also puts a strain on demand.
The most detailed calculations of this effect I’ve seen come from the Brookings Institution’s Hutchins Center, which regularly publishes a “fiscal impact measurement” that shows how the US government’s budgetary decisions affect the US’s short-term growth rate. The key to this measure is that it is used to simplify the process change in the budget balance, which changes growth. And, as the chart below shows, the Hutchins Center has recently estimated that the Hutchins Center has cut its annualized US growth rate by 2 to 3 percentage points since the spring and will continue to do so for the next two years.
These are very large numbers. This “fiscal resistance” is the greatest in decades and is more than the total trend growth in the US in normal times. And while these are US numbers, a similar pattern applies to other rich economies, especially the UK.
Below I’ve given a rough measure of the fiscal impact of government budgets, with the UK (ahead of this week’s budget) lying next to the G7 rich country and euro area average. It is the annual change to the IMF’s October projections of the “cyclically adjusted primary deficit” – the business cycle or interest payments.
It shows that, on average, the UK has seen a much greater budgetary contraction than its competitors. The same picture emerges if I recreate the chart using only the total primary balance (as there are reasons to be suspicious of any method of separating structural from cyclical budget changes in a pandemic).
Will the UK budget change that picture this week? A little, but not that much. This is what the report of the Independent Bureau of Budgetary Responsibility says about the budget:
“The general fiscal stance on which our forecast is based is marked by a sharp tightening between 2021-22 and 2024-25, as fiscal support related to the pandemic is withdrawn – the structural deficit falls from 8.3 to 1 in these three years .8 percent of GDP. “
This sharp tightening persists, although this week’s budgetary decisions resulted in “fiscal stance being significantly loosened in 2022-23 (by 0.8 percent of GDP) and then sums back down again (to 0.2 percent of GDP in the Years 2026-27). ) “. So the government has softened the blow a little (by “making major increases in ministries’ spending, only partially financed by tax increases”), but remains on a course of rapid fiscal contraction.
So what should we think of Britain’s decision to lead the Belt Buckle League? Here are three thoughts.
First, like any other government, UK budgeters expect private demand to decline while the public sector hits the brakes. In a moment of widespread bottlenecks and supply disruptions, that may seem safe enough. But remember that the fiscal contractions have not really started yet and the gap in aggregate demand that needs to be closed will be huge. In fact, the OBR forecast assumes that the household saving rate will shortly fall from a still record level to something even below the pre-pandemic level. Where it does not quite come to that, fiscal consolidation could slow growth sharply, as private demand cannot fully compensate for this. This is why I wrote that we are entering a moment of maximum danger as economies recover from the pandemic.
Second, the UK government is special in that it has for some time been pursuing a restructuring of the government’s economic footprint towards a state that has both taxes and spending as high as it has been in decades. The OBR puts the long-term increase in tax revenue at almost 3 percent and expenditure at 1.8 percent of national income. This is a programmed fiscal tightening in addition to the withdrawal of pandemic support.
Third, the UK may not have much choice. It has damaged its production potential by building trade barriers against its largest market, and many economists expect it to exit the pandemic with more permanent “scars” on its economy than other major economies.
A permanently smaller economy ultimately requires budget cuts to bridge the gap between a lower tax base and unchanged spending plans. Some might think so. Others may think that greater challenges, on the contrary, make it imperative to invest resources in anything that can stimulate the economy. This may mean more borrowing for investment, what government budgets are spent on and where they get their income from, and it may justify higher levels of both taxes and overall government spending. It is hoped that these are the questions that are being asked at Her Majesty’s Treasury Department and Treasury Ministries around the world. They are not easy to answer.
In the run-up to the COP26 climate conference, I interviewed Jeffrey Sachs about what the summit needs to achieve – and many other aspects of our economic future.
The upcoming German government coalition faces the same dilemma at national and European level: How can investments be encouraged within budget rules that discourage them?
My colleague Martin Arnold is analyzing the prospects when the European Central Bank can raise interest rates that stand between market participants and the central bankers themselves.
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