The media has been dominated this week by scary headlines about the mother of all recessions, ballooning government borrowing, and the prospect of punishing tax increases and renewed ‘austerity’. As usual, a sense of context and perspective is sorely needed.
Let’s deal first with the numbers released – or leaked – over the last few days. The official GDP data simply confirmed what we already knew: economic activity began to collapse in March, shrinking almost as much a single month (nearly 6%) as it did throughout the recession of 2008-2009. We also already know that the next set of numbers will be even worse. The lockdown may well have shuttered as much as a quarter of the economy in April.
For what it’s worth (which isn’t much) I’ve therefore pencilled in a further 20% monthly decline in GDP in April, and an 18% quarterly decline in Q2 as a whole.
The good news is that this is largely old news, and not even all bad. Remember that the whole point of the lockdown was to stop most people from doing what they would normally be doing, in order to save lives. No one should be shocked that this has led to a sharp recession (and anyone still questioning whether we are in a recession really should rethink their definition).
It’s no surprise either that this has led to a sharp deterioration in the public finances. Back in April, the OBR’s first attempt at a coronavirus reference scenario predicted that the budget deficit could widen to as much as £273 billion (or just under 14% of GDP). Then earlier this week the Treasury reportedly leaked a new ‘base case scenario’ with a higher figure of £337 billion.
In the event, the OBR published a revised figure today of ‘only’ £298.4 billion (loving the spurious accuracy), with the increase largely reflecting the higher costs of the job retention scheme and lower tax receipts. The main difference between the leaked Treasury ‘base case’ of £337 billion and the OBR’s £298 billion seems to be the underlying economic forecast. The Treasury’s alternative scenario assumes a slower recovery and more (i.e. some) long-term damage.
In contrast, the OBR’s new numbers for the public finances are still based on their April numbers for the impact of coronavirus on the economy. As it happens, I actually think these were a bit pessimistic, at least for this year, especially now that the lockdown is gradually being eased. The government’s hugely expensive schemes have at least succeeded in protecting the great majority of businesses and jobs. Indeed, there are growing signs that activity touched rock bottom last month and a slow recovery has already begun. This may yet mean that the OBR’s next revision is downwards.
Either way, though, these are clearly huge numbers. With only a slightly different set of assumptions it’s not difficult to come up with a borrowing forecast of more than £350 billion for this year. But the more important point is that the fundamental facts haven’t changed – and these are mostly reassuring.
Above all, the increase in annual borrowing is – or should be – temporary. The deficit should drop back sharply next year as the economy reboots, the emergency fiscal support is withdrawn, and tax revenues pick again. There will be a steep increase in the amount of outstanding debt, but this is easily financeable at low interest rates, and the economic recovery will gradually reduce the burden over time.
For this reason, I wouldn’t take the warnings of the need for income tax increases or public sector pay freezes too seriously (though if the pensions triple-lock has to go, that would be welcome). In part these headlines are the familiar Treasury ‘dark arts’ to remind the public – and other departments – that there isn’t a limitless pot of money. After all, a Spending Review is long overdue.
Nonetheless, the deterioration in the public finances can’t be shrugged off either. The Government might find it relatively easy to finance higher levels of public sector spending and borrowing. But as the economy gets back on its feet, there will be a growing risk that this crowds out spending and borrowing by the private sector, whether directly or via higher inflation.
There is also a danger that a narrow focus on the fiscal numbers ignores the broader costs of continued high levels of state intervention in the economy. For example, the priority now, rightly, is to protect jobs. But the longer that the Government continues to subsidise the wages of millions of people, the greater the distortionary impacts on the labour market and on the incentives to work or change job in particular.
In short, the Government will soon need to step aside and let markets work properly again, resisting calls for tax increases or more regulations that would hold back the recovery. In the meantime, we should ‘stay alert’ to the fiscal risks, but there’s no need to panic.
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