The UK budget is presented on Wednesday 21st March. Speaking yesterday, the Chancellor said he had “secured the country’s economic stability”. He is absolutely right: in contrast to previous recoveries, when the economy grew, he has managed to stabilise output. GDP was 0.16% higher at the end of last year compared to the quarter after his first budget. Per capita GDP is over 5% below its peak at the end of 2007.
Jonathan Portes, in a recent post/article, rightly condemns the current pessimism and inaction of the UK government about growth and unemployment. There is so much that could be done, even at this late stage, to start bringing unemployment down quickly. Jonathan suggests a fiscal stimulus (relative to current plans) involving
(1) A temporary cut in national insurance contributions for young and low-paid workers.
(2) Infrastructure investment. (No, it would not take time to find such projects – just reinstate those that were cancelled, like modernising run down school buildings.)
(3) Building more houses by helping social-housing providers to borrow and build. The UK, unlike some other countries, suffers from a structural shortage of housing supply.
I would add a fourth
(4) Reversing some of the changes about to take place in tax credits. This would go a little way towards correcting the fact that proposed budget changes are decidedly regressive in their impact, as I noted here. For more details see this discussion from the Resolution Foundation.
These four proposals would involve more borrowing in the short term. But what if the markets panic? The Chancellor could set in place two contingent policies to deal with this. First, authorise the Bank to undertake more Quantitative Easing if a risk premium on UK government debt begins to emerge. Such a program would be entirely consistent with the Bank’s mandate. Second, set out tax increases that would fully fund measures (1) to (4). This could involve bringing forward the tax increases that are pencilled in for later years, as suggested by the Social Market Foundation here. It could also involve raising taxes that will come largely out of savings, like increasing inheritance tax from the current 40% for example. These taxes would only be increased if the markets showed they could not stomach additional borrowing. They would diminish the expansionary impact of measures (1) to (4), but not by that much because of the balanced budget multiplier. Until now the majority party in the coalition has shown no interest in this way of expanding the economy without increasing debt, but we can always hope.
The government has expressed concern about the evidence (see also Adam Posen here) that small and medium scale firms (SMEs) are being starved of (or priced out of) borrowing by excessively cautious banks. In the UK these firms are unusually dependent on borrowing from banks. Quantitative Easing by the Bank of England has focused on buying government debt, which may have eased the corporate bond market, but has done little for SMEs. The government has so far tried encouraging banks to lend more, with a predictable lack of success. Proposals are due to be announced in the budget, but one of the Bank of England’s leading thinkers suggests radical changes to the UK banking industry are required. Such changes are possible, because the public sector currently owns a good proportion of the banking sector.
Last and not least, the Chancellor should instigate an immediate investigation into the possibility of replacing the inflation target by a nominal GDP target. There is a significant amount of evidence, from the Great Depression and more recently, that expectations of rising prices can provide a strong stimulus to demand. A nominal GDP target, suitably constructed, could help generate those expectations.
If this strikes you as a bit too much, consider the following. In the highly unlikely event that the Chancellor took my advice and the economy started to expand too rapidly, we can cool things down very quickly by using monetary policy. In contrast, being stuck at the zero lower bound means monetary policy with the current inflation target is having little impact on rising unemployment. So for once being incautious is the sensible option.The unemployment rate among under 25s in the UK is currently 22.5% and rising, the highest since records began in 1992. This is no unfortunate accident beyond the government’s control: over 100,000 public sector jobs were cut from education and the NHS in 2011. It is ironic that one of the positive things this government has done is to start publishing survey data on happiness. Alas at the same time its macroeconomic policies are leading to a substantial increase in unhappiness in the UK.