This article was first published in the Financial Times – 07th October 2022.
The “mini” Budget has made a challenging economic environment tougher. The government was right to tackle downside risks and to act decisively to address rising energy prices. But with the markets already in a febrile state, and with the Bank of England proceeding with quantitative tightening, the chancellor, Kwasi Kwarteng, should have stuck to announcing precisely what had been fully expected. Namely, the energy levy, and reversing the national insurance rise and the planned corporation tax increase.
Other details should have waited for a proper Budget, accompanied by costings from the Office for Budget Responsibility. The chancellor should have also avoided further comments on sticking to tax cuts over the following weekend. Now the government has to get the markets onside and prove its fiscal discipline.
Bringing forward the so-called medium-term fiscal plan is key. This should show that the numbers add up, outline the government’s fiscal principles and allay misplaced worries about its view of the UK’s financial institutions.
The affordability of the government’s fiscal plans is the immediate concern. The ratio of UK debt to gross domestic product is manageable, but high. So the public finances are sensitive to the relationship between economic growth and interest rates. As the UK moves away from its addiction to cheap money it is vital that investors have faith in government finances and growth plans. But we must be mindful of how fragile the economy is if the BoE tightens monetary policy too much.
Before the “mini” Budget, the ratio of debt to GDP looked set to rise for a couple of years, either because of deep recession or necessary preventive measures. Using fiscal policy and borrowing to stabilise the economy in the near-term makes sense, but it is critical to show the market a future improving debt path.
If ministers stick with the current measures, spending will be squeezed. Apart from the energy levy, I calculate that 89 per cent of the fiscal easing was reversing the planned rise in corporation tax and National Insurance.
Tax thresholds could remain frozen. Inflation is boosting tax revenues and squeezing spending in real terms. While squeezing public sector spending seems inevitable, the government should avoid a tax-cutting to austerity see-saw. And benefits should be uprated in line with inflation.
Although it is a monetary decision, the BoE could postpone its gilt sales — the market already has enough to absorb — and save significant taxpayer money by paying banks zero interest on reserves.
Markets are uncomfortable with monetary and fiscal policy pulling in opposite directions. But our inflation shock — driven by supply side factors and worsened by cheap money not by an overheating domestic economy — allows scope for some fiscal easing without triggering renewed inflation worries. And the energy levy knocked five per cent off the likely inflation peak.
But the government then needs to communicate the logic underlying its business-friendly growth plan. There are many supply-side reforms that could make a real difference in delivering growth. These need to be implemented but that may now prove politically difficult. Tax cuts are part of, not the whole, picture and alone do not guarantee growth.
The factors needed to improve the investment outlook are known. More finance and lending for firms. Sound macro policies. A skilled workforce. Functioning and supportive infrastructure. A lack of bureaucracy. The level, predictability and simplicity of tax. As well as future expected demand. Ministers need to deliver on what they can control and demonstrate that this is not a quick dash but a sustained investment- driven plan for growth.