The reality behind fiscal scare stories, or mediamacro is alive and well

If you listen to the broadcast media, you will have almost certainly picked up the message that at some point in the near future the Chancellor is going to have to raise taxes or cut spending to ‘pay for’ all the support to the economy during the pandemic. At least the Financial Times has learnt the lesson of 2010, and notes in this editorial that the Chancellor

“must hold the line and resist attempts to push the UK into a premature fiscal retrenchment. Cutting spending in the middle of the worst recession since the creation of the country would be a historic blunder and make Britain poorer in the long run through unnecessary unemployment and business failure.”

If only they had said the same in 2010.

But they add “Eventually the bill for the crisis-fighting measures will come due.” This is also the message of the latest report from the OBR. We can see what they have in mind from this chart.

The upper dotted line is the OBR's worst case scenario. Next one down is the central scenario, followed by another dotted line which is their best case scenario. The other lines are previous forecasts.

All the scenarios, including previous pre-pandemic forecasts, show the same underlying instability. The difference is that as a result of the pandemic, this instability kicks in around the end of this decade rather than sometime in the next decade. Here we get to the crucial point I want to make. For the next five years, in its central forecast public debt moves either side of its projected level for 2020/1 of 104% of GDP. (For each year thereafter: 104, 105, 106, 102.)

The implication is that there is no immediate need for large scale fiscal tightening when the economy recovers. The deficit will be higher than we are used to, but with a higher level of public debt and very low interest rates the level of the deficit that stabilises this debt is also higher. Thus there is no immediate need for substantial tax increases or spending cuts immediately after the recovery is complete. According to the OBR something will need to be done after the general election, but I doubt any Conservative Chancellor will raise taxes substantially ahead of a general election based on OBR forecasts alone.

So the big news from the OBR’s report is not only that there is no immediate need for fiscal consolidation, but if the economy recovers according to its central scenario and it has got its fiscal numbers right, there is no need for substantial fiscal consolidation once the recovery is over. A permanent hit to UK output, which in other circumstances would lead to an unsustainable deficit, has been offset by the impact of low borrowing costs and a higher level of debt. Of course the OBR may turn out to have been too optimistic, and their pessimistic scenario does show debt rising through debt rising a bit between 2020/1 and 2024/5.

So why all the talk of fiscal gloom? (Not quite all. Ben Chu at the Independent has made the points I make above.) Are they reflecting what the OBR says? The report is called the “Fiscal Sustainability Report”, so you would expect them to flag the long term instability. But the final paragraph in their summary ends with this:

“in almost any conceivable world there would be a need at some point to raise tax revenues and/or reduce spending (as a share of national income) to put the public finances on a sustainable path.”

It seems that too many ignored the crucial three words “at some point”.

All this illustrates how deep seated the “deficit up = taxes will rise or spending will be cut” meme is. Of all the important economic stories that arise from this stage in the pandemic, the consequences for the deficit and future consolidation is not one of them. I guess one reason these stories are popular is that they are potentially relevant to everyone. Another is that they are so easy to write. Let us just hope that this time around politicians on all sides are not taking them seriously.

Posting may not happen for two or three weeks, because we are finally moving house..

Why the election for a new Liberal Democrat leader could be the key to voting Johnson out

I would normally have commented on what the Chancellor announced last Wednesday, but much of it was covered in my post last Tuesday where I talked about vouchers, VAT cuts on social consumption, green investment, and unemployment support. The only issue with what he did was that he should have done more of all those things. 

I did not, in that review of interesting policy options, talk about his cut to stamp duty or his £1000 bonus if firms re-employ a furloughed employee, because the former is tried and tested and the latter is not a good policy. The number of firms where that £1000 will make a difference is likely to be very small. The main beneficiaries are companies that do not need help to continue, rather than those who are in trouble because of the pandemic. Which is why the head of the HMRC does not think it is value for money.

Some criticised Keir Starmer for saying the country cannot afford such a costly measure with so little effect, because he implicitly dared to suggest that there was a constraint (beyond inflation) on what the country could afford. The implicit suggestion from some is that there are no limits to what government debt can be. When interest rates control inflation that suggestion is in my view incorrect. While a government that issues its own currency can never be forced to default, it can choose to default (or more likely force the central bank to raise inflation) because the tax burden required to service debt gets too great. While that is a remote possibility today, particularly while real rates are so low, it is prudent not to increase government debt for no good reason. One day real interest rates will rise and then it will be costly to adjust debt quickly. Don’t mention the deficit is a kind of overreaction to austerity. Which brings us to the contest to be next Liberal Democrat leader.

You can frame this contest in many ways (see first hustings here), and one is about the legacy of austerity. Ed Davey was a cabinet minister in the Coalition government that embarked on one of the biggest post-war macroeconomic policy errors since WWII. The other remaining candidate, Layla Moran, was first elected in 2017, and is on the left of the party. Austerity is no longer de rigueur in the Conservative party of Brexiters, but its legacy is still very much with us. Among voters on the left, those who were in positions of power during the austerity period will not be forgiven.

It is not just among the left where the realisation is growing that austerity was a massive error. As a result of the pandemic the government’s deficit is likely to rise well beyond levels seen during the recession that followed the Global Financial Crisis. Yet, if you believed the LibDem leader back in 2010 that we were on the verge of a funding crisis, it is odd that no one is talking about a funding crisis today. It looks increasingly likely that the only material difference between the two episodes is that back then Labour were in power when the deficit rose, and today it is the Conservatives. Either the LibDem leadership at the time shared the Tory desire for spending cuts, or they were duped.

Why does that matter? After all, in most of the contests where the LibDems have a realistic chance of winning or losing it is a Conservative who is the realistic alternative. Following the logic of triangulation, the LibDems just need to be a little to the left on economic policy compared to their Conservative opponent. Anyone further left is less likely to win over voters who would otherwise vote Tory. I have seen this logic used by many supporters of Davey, and I think it is best incomplete

The triangulation logic is based on there being two parties in the relevant contests. In reality there are at least three. As a great believer in tactical voting against the Conservatives, I am always struck at each election at how many Labour votes there are in many LibDem target seats. One of the problems I consistently found in trying to persuade Labour voters to vote LibDem in LibDem target seats in the last election was austerity. More than once I was told ‘I cannot vote for the LibDems when their leader was part of the Coalition austerity government’. Winning target seats is about winning over ex-Labour voters at least as much as it’s about winning over ex-Tory voters.

There is a further point to make. I really doubt that many of those who might switch from Tory to LibDem are going to be familiar with the details of the LibDem manifesto. As long as that manifesto is safe in not containing anything the Tory press can effectively use to frighten voters, whether the LibDem leader is to the left or right in LibDem terms probably matters little. What matters much more is their record. To quote Wera Hobhouse:

“Anyone who voted for coalition policies and, more importantly, anyone who directly served in the coalition government, has a record of supporting and steering a centre-right agenda. Andrew Neil and the wider media were all too quick to point this out when, as leader, Jo Swinson attempted to position herself as progressive.”

Whatever Ed Davey may call himself today, his voting record is not centre-left.

Historically the LibDems have done well when there is widespread dissatisfaction with the incumbent government, particularly Conservative governments. In 1964 their vote share almost doubled compared to the previous election. It more than doubled in 1974 compared to 1970. It rose from just under 14% to over 25% in 1983 relative to 1979. It rose from just under 17% in 1997 to 23% in 2010. Its share today is now well below those heights in part because it is still associated with the Coalition government. The new LibDem leader needs to offer a clean break from that past.

It might seem attractive to some to put aside all thoughts of influencing the government (even Davey has rule out another coalition with the Tories) and try to become the Conservative party that Johnson/Cummings either expelled in 2019 or sidelined in 2020. However there is no future for such a party. As we saw with UKIP, the Conservatives are very good at absorbing any opposition to their hegemony on the right. For the Conservative party Johnson/Cummings are an aberration caused by a referendum gamble that didn’t pay off, and as long as our pluralist democracy survives that aberration is unlikely to last long, and certainly will not survive an election defeat.

The big picture is that the priority for any LibDem or Labour party member, or indeed anyone in the centre of UK politics, should be to preserve our pluralistic democracy and get rid of the Johnson government at the next election. The LibDems need to be part of helping speed the demise of this government. If the Tory lead before the next election is as solid as it is now, then some form of cooperation between opposition parties will be vital in defeating the Conservatives. Whatever form that cooperation takes, it will be made much easier if a minister from the austerity government is not leading the Liberal Democrats. Tribalism prevented cooperation happening in 2019, and leaving the EU plus tens of thousands of unnecessary deaths have already been the consequence. Repeating the same mistake again would be unforgivable.

Sabotaging the recovery

I wrote last week about how a premature easing of lockdown in the UK would cost many more lives. This post will be about how it is also likely to create a weak recovery where some businesses will go to the wall and many jobs will be lost.

A good starting point in thinking about the kind of recovery we could have is to think about synchronized holidays, like Christmas or the summer holiday in much of France. Most of the economy closes down for a few weeks, but starts up again without any long term harm done. You get a V shaped recovery, which we never notice because it gets seasonally adjusted out of the data.

A few months is not fundamentally different from a few weeks, if the government provides sufficient support to firms, the self employed and individuals? The absence of such support gives us the first reason why a recovery might not be V shaped. Yet the UK government’s support over the last few months has been reasonably good, albeit with some notable exceptions.

After a holiday involving a few weeks, consumers’ preferences will be unchanged. Is the same true of a pandemic? If the virus has disappeared for good, or immunity against the virus is complete (with a vaccine, say), there seems no compelling reason to believe otherwise, although overseas travel will require the virus to have disappeared in other countries as well. Perhaps some consumers might initially not believe the virus has disappeared, but this might be offset by other consumers spending more time on social consumption than normal in celebration that the pandemic has ended. In some sectors this second effect could even lead to a larger recovery than the initial recession.

The main reason a V shaped recovery is not going to happen in the UK is because the virus has not disappeared. Compared to other European countries the number of new infections remains high, and as a result many consumers will be understandably reluctant to resume their normal patterns of social consumption. If the government also withdraws support from social consumption sectors, this inevitably means firm closure and firm downsizing, leading to a large increase in unemployment. Restoring confidence in countries where the virus has largely disappeared will not be easy, but that task is much harder when the risks of catching the virus are non-negligible.

There is a further hurdle in the face of a recovery that this government has created. Whatever the new number of infections are, will consumers trust the government when they are told they should resume social consumption? Almost everything the government has done to combat the virus has been a failure. The latest is withholding until recently Pillar 2 data from local authorities and the public. When people are told it’s their civic duty to resume social consumption, rather than simply being told what the risks of doing so are, they are bound to be suspicious of the government’s motives, and who can blame them.

The continuing high level of infections and lack of trust mean that many consumers will not resume social consumption. This poll shows that people’s perception of the risk from the virus has recently increased. This is the inevitable result of prioritising the economy rather than getting new infection numbers right down.

So what can be done? The government is not going to drive new infections down much lower by opening up pubs! It is not going to get trust back anytime soon. Can the Chancellor encourage reluctant consumers to resume social consumption by some means? A general fiscal stimulus, in the form of a tax cut, is unlikely to do much in this respect, because most of it will be saved. Furthermore what is spent is likely to go into sectors that can make a reasonable recovery, like clothing and consumer durables. Other forms of standard fiscal stimulus, including a VAT cut, are unlikely to avoid large scale redundancies from social consumption sectors.

The Resolution Foundation has a more interesting proposal, which is to give vouchers that are time limited that can be spent in vulnerable social consumption sectors (and which are switched off if a second wave appears and we have to go back into lockdown). This is the kind of sector specific stimulus we need. Another possibility would be a temporary cut in VAT on social consumption goods.

Even with such schemes, we are unlikely to see a full rebound in social consumption for some months to come. In a few specific areas social distancing means venues will inevitably be operating at a loss. Subsidies of various kinds to keep firms going and to avoid as far as possible large scale redundancies will be necessary.

While a general fiscal stimulus will not solve sector specific problems, if interest rates remain at their lower bound there is strong a case for economy wide fiscal support. Aggregate demand may remain low as investment is depressed by Brexit and uncertainty about a second wave. If the Chancellor is looking at ideas for what this stimulus could be, or more generally in how to meet our climate change goals, here is a report from NEF.

However unemployment will inevitably remain too high. As Paul Gregg notes, this prolonged recession will be much more unemployment intensive than the recession after the Global Financial Crisis. But just as fiscal stimulus can be regarded as an opportunity, so job losses can be seen as a chance to reskill the UK workforce, along the lines suggested by Jonathan Portes and Tony Wilson. However some of those working in areas where social consumption is low because of the pandemic may wish to remain in those sectors once demand picks up because new infections decline significantly or a vaccine is developed. It is worth noting that a Job Guarantee, if such a scheme existed, would provide an excellent chance for these people to do something useful in this enforced break in their careers.

These are all policies that will have much more work to do because this government made yet another error in their handling of this pandemic, which was to ease the lockdown while the number of new infections was still quite high. Most experts, and indeed most academic economists, understood it would be an error before it happened. It is an error that could sabotage what might have been something close to a V shaped recovery.