Winner of the New Statesman SPERI Prize in Political Economy 2016


Monday, 18 May 2020

On V shaped recoveries, and where the Treasury’s deficit obsession will matter


I should perhaps go through some of the thinking that lay behind my Guardian article about not repeating austerity, because I fear there is a danger of worrying about the wrong thing. I have always been reasonably confident that we would not get an exact repeat of 2010, where the Chancellor says at the low point of a recession (i.e. before a recovery has begun) that we have to start cutting back spending because the deficit is too high.

There are two reasons for that confidence. First, the circumstances that allowed 2010 were uniquely advantageous. We had just had a global financial crisis, so false claims about what financial markets might do seemed plausible. There was also a Euro crisis. Everyone was saving more (or borrowing less) as a result of the financial crisis, so you could easily persuade people the government should too. And finally we had had a period of strong growth in some public services under the Labour government.

None of that holds today. Most people have had enough of austerity, something our Prime Minister understands. He knows there are huge political dangers in worrying about debt just after a pandemic where the government’s decisions have been woeful. The media will obsess about the deficit, but I think the government at the moment is going to ignore them.

I wrote the Guardian piece because I realised that not only had the media not changed, but neither had the Treasury. The leaked document I discuss in that article showed that, but there was much stronger evidence of their concern, and that was the Chancellor channeling their pressure to ease the lockdown as soon as possible.

Austerity is a type of short term penny pinching by the government leading to much larger longer term costs. The only justification for relaxing the lockdown by forcing large sections of (typically working class) workers to go back to work is saving the Treasury money on furloughing, which is why the pressure to relax furloughing is coming from the Chancellor and the Treasury rather than No.10. The cost of this is to raise R (how many people someone who has coronavirus infects). The point I make here is that most of the economy will only recover once people are no longer fearful of catching the virus, which means the number of new infections nationally per day must be very low, maybe even single figures.

If R is currently something like 0.2, and if the recent relaxation raises it to 0.3, then the number of new infections is going to fall pretty rapidly anyway. But if R was 0.8, and it now becomes 0.9 as a result of more people at work, then it will take considerably longer to get infection numbers down. So pressure to save some money on furloughing may in the end cost much more by setting back the date of recovery by months.

There is a second sense in which Treasury penny pinching may end up costing a great deal, and it reflects what happened with austerity from 2013 onwards. There has been a great deal of discussion about the nature of the economic recovery from this pandemic, and how much long term damage it could do. When I suggested that in principle there was no reason for the economy not to bounce back, the general consensus on twitter was that there was no way that is going to happen.

The problem with the belief that the economic recovery will be neither quick or complete is that it can be self-fulfilling. It always amazes me how many economists were quite happy to believe that the sudden stop in UK productivity growth after 2010 was somehow caused by the financial crisis (or something else) and had nothing to do with a sustained period during which aggregate demand was being depressed. Once policymakers start believing that, you don’t get the stimulus measures you need to get a complete recovery. Once economic actors believe in it, then it becomes a self-fulfilling result.

Exactly the same could happen after the pandemic, particularly if it takes time before the number of daily infections becomes very low. Consumers may be cautious about embarking on forms of social consumption again, and so it appears as if the V shaped recovery is not going to materialise. What should happen at this point is that the government stimulates the economy in some way, to quickly mop up the additional unemployment created by the pandemic. Instead, I fear that inside the Treasury concerns about the deficit will override their responsibility to stabilise the economy when interest rates are at their lower bound. Indeed I have never been sure that this Treasury accepts that responsibility.

I have always thought that if the pandemic is handled properly, with good support during lockdown and appropriate stimulus subsequently, then a V shaped recovery will happen. There is no reason to have additional unemployment or permanently lost output once the virus is tightly controlled and consumers recognise their chance of getting it are minimal. We will see something close to a complete recovery in the countries that have handled the pandemic well, restrained only by what is happening in the countries with less capable governments. What will stop us having a V shaped recovery is government incompetence, both in handling the pandemic and in how macroeconomic policy supports the recovery.





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