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Quick take: Austerity deferred in the UK
Robert Lind
November 21, 2022
It is hard to believe but just under eight weeks ago, Kwasi Kwarteng, then UK chancellor, announced his ‘growth plan’ comprising the Truss government’s energy price guarantee and large tax cuts. At the time, I described the announcement as radical and reckless; it incorporated the largest tax cuts since Tony Barber’s ill-fated fiscal gamble in the early 1970s that stoked an unsustainable inflationary boom.
Within a month, the Truss-Kwarteng government’s fiscal plan had imploded, leading to the resignations of the chancellor and prime minister. After their departures, it was clear the new government would face substantial policy challenges and, last week, new chancellor Jeremy Hunt put forward revised fiscal plans in his autumn statement. While I feel this is a more balanced set of policies than the Truss-Kwarteng package and spending cuts have been pushed back, whoever wins the next general election will still have to deal with another round of austerity.
Over the last few weeks, Hunt and prime minister Rishi Sunak have emphasised their commitment to restoring the UK’s policy credibility. Hunt’s reversal of most of the Truss-Kwarteng fiscal measures has helped calm markets, providing support to gilts and the pound (although a more benign outlook for global interest rates has also helped substantially). In his autumn statement, the chancellor spoke forcefully about the government’s commitment to fiscal discipline but was also keen to emphasise the need to support the economy in the face of a huge stagflationary energy shock, which has boosted inflation and pushed the UK into recession.
Amending the terms of the Truss-Kwarteng energy price guarantee, Hunt confirmed a cap on the average household energy bill at £2500 until April 2023, and then at £3000 to April 2024 (when the cap expires). The Office for Budget Responsibility (OBR) estimates this will cost just over £50 billion over the next two years. Businesses will also get relief on energy bills until April 2023 at an estimated cost of £18.5bn.
In addition to energy support, the government has decided to stick with the Truss-Kwarteng decision to reverse the increase in national insurance contributions (that took effect in April and was announced by Sunak as chancellor). The reversal takes effect this month, with a full-year cost of around £17-18bn. They will also stick with the Truss-Kwarteng plan to cut stamp duty for some house purchases. Alongside these cuts, the chancellor announced a significant rise in public spending, with an uprating of welfare benefits in line with inflation (10%) and increases in the health, education, and defence budgets. He also reaffirmed cash increases in the capital spending budget over the next two years.
As a partial offset to the short-term fiscal loosening, Hunt announced substantial tax increases, with a reduction in the threshold for the top rate of income tax and a temporary windfall tax on energy companies. He confirmed there would be no changes in tax rates but will freeze personal allowances and tax thresholds for the entire period to 2027-28. The cumulative effect will build so these effective tax increases will raise around £31bn by 2027-28. Finally, the chancellor also announced plans to cut public spending beyond 2024-25 (the next general election must take place by January 2025).
While there has been speculation about another round of austerity, Hunt is effectively pushing the bulk of the fiscal consolidation until after the election. He clearly hopes another chancellor will have the responsibility of delivering on his plans.
Once the chancellor had finished his statement, the OBR published its revised macroeconomic forecasts: in 2023, it expects UK GDP to fall by 1½%, opening up a substantial negative output gap to put downward pressure on inflation. It also predicts a gradual pick-up in potential output growth.
On this basis, the OBR is anticipating CPI inflation will be back below the 2% target early in 2024. This is broadly similar to the Bank of England’s forecast, though members of the Monetary Policy Committee have admitted there are upside risks to their inflation forecasts.
As stated at outset, in my view, the autumn statement adopts a more considered and balanced approach to fiscal policy than the Truss-Kwarteng ‘growth plan’. Hunt has effectively loosened fiscal policy in 2022-23 and 2023-24 with the energy price guarantee, increases in welfare benefits, and the reversal of the increase in national insurance. But this loosening looks sensible in the context of the expected recession in 2023.
Short-term fiscal easing will likely encourage the Bank of England to raise its policy interest rate to around 4% over the next few months. But weaker economic growth and expectations of lower inflation should allow the Bank to stop short of current market expectations, which predict the rate at 4½% in 2023. Hunt also outlined a medium-term consolidation plan with backloaded tax increases and spending restraint (particularly after the next general election in 2024-25). The next government – either Conservative or Labour – will have the more difficult challenge of implementing ‘austerity 2.0’.
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