The long march to economic ‘credibility’. Fiscal policy debates are heating up in the run up to the Autumn Statement on the 17th November. Treasury sources have been briefing journalists the gory details of the rumoured ‘black hole’ in the public finances and dropping hints about measures being considered to fill it. The latest estimates report that Chancellor Jeremy Hunt is planning cuts and tax rises totalling £60bn (at least half is expected to come from spending cuts) as he attempts to restore the Conservative party’s reputation for economic credibility. (Be warned: there is a large amount of expectation management going on from the Treasury, so take all reports of figures or policy options with a pinch of salt).

  • A comprehensive explainer of fiscal responsibility. But what is fiscal space, how much does the government have, and what determines the options available to the Chancellor? Spending and Stability, a timely briefing by IPPR’s Carys Roberts and Carsten Jung, outlines the macroeconomic situation after the mini-budget and clarifies what the real constraints on tax and spending decisions are going forward.
  • Inflation and sustainability are the only constraints. The authors explain there is little justification for the government narrative of a multi-billion pound ‘black hole’ which must be filled immediately to avoid economic calamity. In fact, the primary short-term constraint is the risk that any tax and spending decisions further stoke inflation (which they argue was the main driver behind the mini-budget “market turmoil” - read our analysis of the mini-budget’s contents and reaction) and the only medium-term constraint is the Chancellor’s choice of fiscal rules (a self-defined measure of sustainability).
  • Room for additional spending. In the short term, IPPR argues that there is room for the government to raise spending to combat the cost of living crisis and invest in policies that will lead to economic growth, as long as inflation pressures are controlled. In the medium term, even the governments’ own fiscal rules do not prescribe spending cuts. Instead, a mix of policies (such as public investment) that increase growth (and thus lead to higher tax receipts and lower public spending) combined with some tax increases, would provide a credible fiscal strategy. This kind of countercyclical fiscal policy would be a more normal response to an impending recession, as the BBC’s Andy Verity explains. 

Debt sustainability and fiscal rules. At the heart of this debate is the UK’s framework of fiscal rules. Fiscal rules are chosen by the Chancellor: they are a commitment to certain debt management policies to assure investors in UK public debt that there is a plan to ensure debt levels remain manageable - violating this can lead to higher risk premiums, leading investors to charge more interest on the debt. There are multiple fiscal rules, but the important one for this debate is the commitment to ensure the UK’s debt-to-GDP ratio is falling by the third year of the OBR forecast (i.e. by the end of 2025). This is a rolling target, so in some ways it can never be reached, but it does oblige the government to attempt to set out policies to meet it, which the Office for Budget Responsibility assesses. The ‘black hole’ is the anticipation of how far the government is away from meeting this self-imposed rule. 

Reducing the debt-to-GDP ratio through contractionary policy is self-defeating. IPPR’s point is that the size of the hole in public finances changes depending upon the policies chosen to fill it. George Osborne (in)famously tried to reduce the government’s debt-to-GDP ratio in the 2010s by heavily focusing on cuts to public spending. This approach has been roundly criticised by major economic institutions as a failure; across 32 of 32 advanced economies, reduced government spending led to slower economic growth. Contractionary fiscal policy, such as certain tax rises and spending cuts reduce spending in the economy and therefore negatively impact growth, making the hole in the public finances larger. In other words, if you want to meet a debt-to-GDP target, then the GDP is as important as the debt.

Avoiding the “doom-loop”. The CBI’s Tony Danker, head of the UK’s largest business lobby group, warned PM Rishi Sunak against repeating the mistakes of the Cameron-Osborne years and creating a contractionary ‘doom-loop’; where tax increases and spending cuts harm growth so “the country could end up in a similar doom loop where all you have to do is keep coming back every year to find more tax rises and more spending cuts because you’ve got no growth.” The rumoured Treasury calculations admit the risk of this ‘doom-loop’ taking hold where estimates of the initial fiscal hole rose from ~£30-40bn to £50bn because more tax rises or spending cuts “will worsen the economic outlook, which will in turn hit future tax revenues”.

Achieving debt sustainability through growth. IPPR criticise the IFS’s estimate that £25bn of spending cuts are needed to meet the government’s current debt-to-GDP rule because this is based on near 0% growth in the medium term and 1% rise in interest on public debt. They argue that if the UK returns to pre-pandemic growth and interest rates closer to 2%, then the UK can afford to run a deficit of £49bn until 2025 and still be stabilising its debt - with £74bn more fiscal space than the IFS’s estimate.

No public appetite for austerity. Another consideration in this debate is how politically deliverable a programme of fiscal restraint would be in practice. Public attitudes on the economy have shifted since the 2010s. Deficit management is much less salient in the public's judgments about economic performance than it was in 2013; voters are now “most likely to be influenced by information concerning inflation/increases in prices”. NatCen’s latest British Social Attitudes survey shows “Appetite for government intervention in the economy is rising, as is concern about inequality, and enthusiasm for redistribution of income from the better-off to the poorer”. Those who want to increase taxes and spend more on health, education and social benefits was at its nadir at 31% in 2010, but has been climbing since - since 2017 more of the public want the government to “increase taxes and spend more” than those who want it to “keep taxes and spending at the same level as now”. 62% of 2019 Conservative voters think wealthy people should pay more tax.

Weekly Updates

Monetary policy and inflation

BoE raises interest rates as stagflation sets in. The Bank of England’s Monetary Policy Committee voted to raise interest rates from 2.25% to 3% last week. The Bank is predicting the longest recession since the 1930s (to last until summer 2024) with unemployment forecast to double. Continued contractionary monetary policy during a recession has sparked debates over central bank independence.

Tackling inflation without monetary policy. An article from Vox’s Madeleine Ngo outlines various options available to the US Congress in its battle against inflation. The Groundwork Collaborative’s Lindsay Owens explained that competition policy to break up concentrated industries could prevent price gouging from corporations engaged in “coordinated price hikes”. 


Windfall tax on the banking sector. Ex-deputy governor of the Bank of England Charlie Bean has suggested imposing a windfall tax on UK Banks. Research by NEF has shown increasing interest rates to 3% could lead to private banks receiving up to £27.62bn by March 2023; this could rise to £161.80bn if interest rates rise to 4%. 

Lost revenue to tax havens. A new working paper by economists Ludvig Wier and Gabriel Zucman finds that profit shifting has increased “relentlessly” from 1975 to 2019, where multinational corporations shifted nearly $1tn in profits to tax havens in 2019.

How much could a wealth tax actually bring in? Labour MP Beth Winter explained that the government can afford to increase public sector pay by levying a one-off or annual wealth tax to the Wealth Tax Commission. She outlined how much revenue could be raised from a variety policy options from Arun Advani, Adam Summers, Tax Justice UK, IPPR and Common Wealth in a short video.

Paradigm shift

Evolution of Conservative economics. Onward has published a paper by Tim Pitt, former adviser to Chancellors Phillip Hammond and Sajid Javid, The Road to Credibility: Conservative Principles for the Path Ahead. Pitt summarised how new economic challenges necessitate a shift beyond free market principles in a Twitter thread. These include: an empowering state, tax reforms focused on earnings, business property and wealth and more.

Centre-right industrial strategy. Six conservative-leaning economists have proposed ten “politically and fiscally possible” ideas for boosting economic growth that have support on the centre-right. These include increasing domestic energy supply, reducing energy demand, decentralisation of power away from Westminster, reforming the planning system to build more housing, preserving R&D investment, and more.

Energy and welfare

Spring deadline to tackle “fuel poverty emergency”. E3G warns of a “fuel poverty emergency” next April with 11 million households at risk if household energy bills surpass £4,000 a year. They have published options for short and medium-term solutions to protect households from volatile gas prices

Climate change

COP27 continues this week in Egypt. New Economy Brief will cover the main outcomes of COP27 when it is over. In the meantime, sign up to climate journalist Ed King’s newsletter for daily updates