The case for a UK fiscal reset
Lucy O’Carroll, chief economist – investment solutions at Aberdeen Asset Management, looks at the other side of the equation: fiscal policy in response to monetary policy measures catching all the headlines.
Chancellor Philip Hammond has said that the UK may have to “reset” fiscal policy in the wake of the referendum vote. This sentiment appears to chime with the mood music at an international level, as G20 finance ministers and central bank governors make yet another plea for the use of fiscal policy to boost global growth. So how likely are we to see a change of direction in UK tax and spending policy – and will it help?
Mr Hammond has said that this year’s Autumn Statement will provide the opportunity to reset fiscal policy if the economic data worsen over the next few months – but that is still an “if”.
"The least we can expect this autumn is some tax cuts and a number of spending projects to encourage businesses, consumers and investors to retain faith in the UK economy."
As yet, we have no ‘hard’ data showing the impact of the referendum vote. We do, however, have a number of surveys and their tone has generally been negative.
On the consumer side, the widely used GfK consumer confidence measure showed its largest fall for 21 years in the post-referendum period, though it still remains at reasonably positive levels. As for businesses, surveys from the Institute of Directors and Deloitte point to deteriorating business conditions; in contrast, a Bank of England survey reported “no clear evidence of a sharp general slowing in activity”, though a third of companies thought they would cut investment plans in the year ahead. The Purchasing Managers’ Indices were starker still, showing activity falling to its lowest level since 2009. The question is ultimately whether the surveys will prove to be a reliable guide to activity, given the unusual nature of the post-referendum situation. Unfortunately we will not have a full answer until November, when third-quarter estimates for business investment and household spending are due to be published.
In the short term, therefore, the Bank of England will take the strain. Most members of the Bank’s Monetary Policy Committee (MPC) expect policy to be loosened at its August meeting, after discussing “various easing options and combinations thereof” this month. Indeed, the negative tone of post-referendum surveys convinced Martin Weale to declare “I see things rather differently from what I would have done had we not had those numbers”. And the MPC didn’t disappoint, announcing a combination of interest-rate cuts, quantitative easing (QE) measures and direct liquidity provision.
Cynics might say: so far, so familiar. Monetary policy has, after all, been the ‘go to’ stimulus tool for much of the period since the Global Financial Crisis (GFC). Could the MPC’s actions let Mr Hammond off the hook later in the year? The short answer is no – for four reasons.
- Reason #1: Former Chancellor George Osborne’s fiscal calculations and framework have been trashed… Not least by Mr Osborne himself, who abandoned his target of eliminating the budget deficit by 2020 just before being sacked by Prime Minister Teresa May. Mr Osborne explained that his move reflected the need to be “realistic” about the negative impact of the referendum result on activity and tax revenues. Mr Hammond is unlikely to disagree – and will want to stamp his personal authority on his new role.
- Reason #2: Monetary policy acts with a lag… Action taken in August is therefore unlikely to give the economy a quick boost. Indeed, Martin Weale acknowledges that “If we’re talking about having an effect by the end of the year, there is very little that the Bank can do”. So without the prospect of fiscal stimulus to come, sentiment may remain fragile (and spending and investment plans on hold) as the MPC’s announcements take time to work their way through the economy.
- Reason #3: Monetary policy may be running out of road… UK interest rates are already at a record low of 0.25% and – as the response to recent moves by the Bank of Japan and European Central Bank has shown – cutting rates to zero or into negative territory can be problematic, not least for the banking sector’s profitability.
There is also some evidence that the economic benefits to fresh waves of QE diminish over time. Central banks will, of course, continue to innovate; but the challenge of instilling confidence (and underpinning activity) becomes more complicated as policy itself becomes more complex. In this situation, fiscal stimulus can provide a useful – and perhaps more easily understood – backstop.
- Reason #4: Recent policy choices and the rise of populism may be linked… The UK’s recovery from the GFC may look decent on paper – according to Bank of England figures, GDP is now 7% above its pre-crisis peak, employment is 6% higher and wealth has outstripped its pre-crisis high by 30% – but the underlying picture is more nuanced.
Taking a regional view, only in London and the South East has GDP risen above its pre-crisis peak when measured per head of population. The rise in wealth has also been unequally distributed: the wealth of the bottom income quintile has fallen since 2010, while the wealth of the top quintile has risen by nearly 20%. So what is the link to policy? By driving up asset prices, monetary stimulus has favoured asset holders; at the same time, Mr Osborne’s fiscal squeeze has impacted those at the lowest end of the income and wealth distributions most.
Other factors have been at work, of course. Globalisation and the impact of technology on the availability of low-skilled jobs are amongst the most obvious. But this monetary/fiscal policy combination, and the disparate trends in incomes, wealth and wellbeing that it has helped foster, may make clear and apparently simple political solutions look attractive.
The least we can expect this autumn is some tax cuts and a number of spending projects to encourage businesses, consumers and investors to retain faith in the UK economy. The chances of more substantive change appear slimmer, despite the pleas of the G20.
Other countries may also be contemplating a rethink on the balance between monetary and fiscal policy, and for similar reasons. Only the UK, however, is doing so while simultaneously engineering an exit from a decades-long relationship with major trading partners. A radical new UK fiscal framework may be a challenge too far for Mr Hammond at present.