Could we be about to see a shift from austerity to fiscal expansion? The UK’s new finance minister, Phillip Hammond, as reported by the BBC here, has signalled that he may ‘reset’ economic policy at his next budget statement come Autumn.
There are some indications that the UK economy has been subject to a substantial negative ‘shock’ as a result of Brexit, the UK’s vote to leave the EU. The latest business managers survey showed a sharp move towards economic contraction. If this heralds a significant growth slowdown or even recession, the budget deficit will tend to increase as a result, even if the government does nothing. This is because slowing or negative growth reduces tax receipts and usually leads to higher spending on unemployment benefits and welfare, automatically increasing government borrowing. If this extra borrowing boosts spending in the economy overall, then it is known as the ‘automatic stabilizer’, in effect stabilizing the economy by compensating for lower private spending.
Mr Hammond could also increase borrowing further through tax cuts or extra spending on infrastructure, beyond what happens automatically, in order to try to boost growth. Alongside the abandonment of his predecessor George Osborne’s aim to achieve a budget surplus, in which tax receipts are greater than public spending, by the end of the parliament in 2020, this would represent a significant policy shift away from austerity.
Given that the government’s cost of borrowing is still very low, many economists have argued that now is the time to increase public investment in suitable infrastructure projects, which could have a much higher return than the interest rates that it pays on newly issued bonds, used to finance the borrowing.
It is also clear that the Bank of England has little room to expand demand through monetary policy. Interest rates are already near zero, and while it could engage in more quantitative easing, there is the worry that this will simply boost asset prices while having little effect on the real economy, other than some sort of wealth effect on the holders of those assets, who may increase their consumption levels (or they may not).
What I would argue is vital to any resetting of the UK’s economic policy, is a focus on rebalancing the economy away from borrowing, consumption and imports and towards investment and exports. The recent sharp fall in the pound since that vote for Brexit may help this process, but it depends on how the change in the price of tradeable goods and services (imports and exports) affects their demand, and whether or not a weaker currency is sustained. The latter will help businesses plan over a reasonable period and will make it more likely that they can affect a rebalancing. All of this will help to reduce public and private sector borrowing if the current account deficit falls from its current level, the highest since records began. This will make it easier to reduce the government’s deficit with a less harmful effect on overall growth and employment.
If devaluation by itself does not significantly rebalance the UK economy, then more proactive policies may be needed to increase the international competitiveness of exports and industry in general. This is usually called industrial policy and the new government has made some positive noises about this, and has even changed the name of the business ministry to the Department for Business, Energy and Industrial Strategy. But it remains to be seen whether this will prove merely cosmetic or represents a new commitment to promoting industry through state intervention. As it is the Conservatives, who tend to place a great emphasis on the importance of the free market, I am not holding my breath.