When you’re in a budgetary hole, stop digging. This has been the attitude Jeremy Hunt has adopted since being appointed chancellor four weeks ago.
Ever since September’s “mini” Budget, when financial markets lost confidence in the health of the UK’s public finances, it has been clear the country will pay a price for that mistake. The government’s average borrowing cost has gone up from 1.1 per cent at the start of the year to 3.8 per cent this week.
The vast majority of this increase reflects global forces — rising inflation and higher interest rates — but the markets are watching. They will be more exacting in assessing UK budgetary plans than for most other countries and Hunt knows he must present a convincing case. In Thursday’s Autumn Statement he needs to demonstrate sustainable public finances, credible policy measures, and borrowing and debt that will be resilient to some further economic shocks. This is why the chancellor talks so frequently about “eye-wateringly” difficult decisions.
Chief among these choices is what balance to strike between tax increases and spending cuts. It is almost certain that he will opt for the relatively easy options of allowing inflation to drag people into higher tax brackets, rather than putting up rates, and cutting some investment expenditure — scheduled to be at historically high levels — instead of squeezing public services too much.
Those are in the bag, but will not be enough to close the fiscal hole, which Treasury insiders put at a little over £50bn a year by 2027-28, when the economy should be back to working normally.
The remaining measures will reveal whether Hunt has prioritised good economics or smart politics in this statement. Economics suggests he should front-load the extra pain, putting in place almost immediate spending cuts and tax increases similar to the programmes followed by Norman Lamont and Ken Clarke in the early 1990s.
That would not necessarily deepen the coming recession, since the Bank of England is there to moderate demand and offset a fiscal contraction with interest rates that are lower than they otherwise would be.
With interest rates at 3 per cent, the BoE has scope to loosen monetary policy if necessary because the immediate budgetary tightening is sufficiently aggressive. Let us be clear. The UK’s central bank thinks a recession is needed to tame inflation, but there is no need for it to be deep, so long as companies do not seek to push prices up excessively and workers moderate pay demands.
In this scenario, by the next election (which has to be called by late 2024) inflation would probably be under control and there would be scope for a period of faster than normal growth. Front-loading the budgetary repair job would have been the necessary step, instantly making UK economic policy credible. There might even be some further gains to be enjoyed from financial markets looking favourably on prudence, further lowering borrowing costs.
The problem with front-loading is that it is terrible politics. Immediate tax rises and spending cuts would be unpopular with Conservative MPs and across the country. Sorting out the public finances would put the UK in a better position for the second half of the decade, but that’s when Labour is likely to be in power.
There is therefore a risk that Hunt backloads difficult decisions to 2025 and after and minimises the immediate political pain from fiscal consolidation. If Labour wins the coming election, it inherits weak public finances and huge demands for better public services.
Financial markets might well think that this government pledging that the next one will run sustainable public finances is not credible and, once again, punish the UK. Hunt’s big choice therefore is economics or politics. It will be the making of this chancellor.