Chancellor of the Exchequer Jeremy Hunt unveiled a sweeping £55bn ($66bn) fiscal plan in his highly anticipated inaugural autumn statement.
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LONDON — The recent fiscal announcement from Britain’s Chancellor of the Exchequer, Jeremy Hunt, left a “massive” gap where an economic growth strategy should be, according to former Bank of England policymaker Michael Saunders.
Last week, Hunt announced a £55bn ($65.2bn) program of tax increases and spending cuts as he sought to plug a hole in the country’s public finances.
This came as the independent Office for Budget Responsibility confirmed that the UK economy is already in recession and will contract by 1.4% of GDP in 2023, while living standards are projected to fall at their strongest rate on record.
Saunders, who served on the Bank of England’s Monetary Policy Committee from August 2016 to August 2022, told CNBC on Monday that reduced trade intensity due to Brexit and lower productivity growth have permanently hurt potential output.
The OBR estimated in May that the UK’s new terms of trade with the European Union, set out in the Trade and Cooperation Agreement (TCA) which came into effect on 1 January 2021, will reduce long-term productivity by 4% compared to the previous trajectory had left the UK in the EU.
“Part of the reason things are so bad is that potential growth is so weak and is expected to be weak,” Saunders said.
That is why, according to the MPC, while GDP is expected to be slightly lower than Q4 2019, they believe the economy is in significant surplus, in other words, has overheated even without growth. think that potential output growth for the next few years will be less than 1% per annum.”
Essentially, the shock to the economy driving inflation is not stronger-than-expected output or demand, but rather a shortfall in output on the supply side of the economy, meaning the bar for excess demand to overheat the economy is much lower. is.
“The big surprise of the past year is not that the economy has been stronger than expected, because it has not, but that the supply side of the economy is weaker than expected, with the result that unemployment is lower than expected and domestic inflation pressures are stronger than expected, even though GDP growth is not stronger than expected,” Saunders explained.
He added that monetary policy must therefore ensure that the economy does not grow faster than the current anemic rate, as potential output growth is weak, meaning that the government must resort to “little or no growth in government spending or a rising tax burden”. if it wants to put its fiscal position back on a sustainable path.
“If you think about this past output path, the MPC and OBR think potential output is lower than Q4 2019, but… three years from now at the pre-pandemic pace, you’d see potential output growth of probably 4 .5%, something like 1.5% a year, so it’s that shortfall versus what was a pretty miserable trend anyway,” Saunders said.
“We’ve been saying for most of the last 10 years that potential output growth is weak, because look how far we’re below the pre-GFC (Global Financial Crisis) trend, and now we’ve even fallen below the post-GFC trend .”
Hunt’s fiscal plans include around £30bn in government spending cuts, the deepest of which have been heavily delayed beyond April 2025, which would be after the country’s next general election.
“I thought the fall statement just had a huge hole where a long-term growth strategy should have been,” Saunders told CNBC by phone.
Postponing government spending tightness isn’t really about improving long-term growth prospects, it’s about mitigating the pain of adjusting to low potential growth.
A spokesman for the UK Treasury Department was not immediately available for comment when contacted by CNBC.
He noted that cuts in public investment, which made up a significant portion of government spending, “is likely to worsen potential output growth,” highlighting OECD studies pointing to a broad payoff of public investment for potential growth.
A 2016 OECD report found that public investment “has a positive effect on long-term growth and labor productivity” and can also “increase the rate of convergence of catching-up countries”.
“If you want to go through fiscal consolidation, the least useful thing to do is cut public investment,” Saunders added.
His comments were echoed on Sunday by Britain’s largest business lobby group, the Confederation of British Industry. Director-General Tony Danker told the BBC that Hunt had seemingly prioritized stability over growth, but that without higher growth the country would not be able to afford the rising costs of health and social care.
Danker told the BBC the autumn statement was “all about fighting inflation and getting the government budget in a decent way and that needs to happen” but added that “there was nothing telling us the economy will avoid another decade of low productivity and low growth.”