Number 11 Downing Street

A good start, but the markets may take fright again on Halloween

Published on 18 October 2022

"Only a reversal of direction on that scale was ever going to be enough to reassure the markets and start to get fiscal policy back on track."

Thank goodness for that. Only a reversal of direction on that scale was ever going to be enough to reassure the markets and start to get fiscal policy back on track. Nearly all the big tax cuts have been abandoned and the government can start again with something close to a clean sheet. The government and the Bank of England are no longer pulling the economy in opposing directions.

The decision to review the energy support package was as welcome as the about-turn on long-term tax cuts. A huge, expensive, unfunded, untargeted intervention may have been just about excusable as an emergency intervention this winter. It was always inexcusable to announce that it would still be in place next year, by which time something far better, cheaper and more targeted could surely have been designed and implemented.

It wasn’t just the big decisions that were so important, some of the smaller ones were too. Keeping the stamp duty cut and the increase in capital allowances for corporation tax were good, and growth-friendly, policy changes. They are to be retained. The extraordinary decision to effectively give up on policing off- payroll working arrangements has, thank goodness, been abandoned.

The question now is: what next? In two weeks’ time, on October 31, Jeremy Hunt will be presenting a new fiscal strategy alongside economic and fiscal forecasts from the Office for Budget Responsibility. Even after the abandonment of most of last month’s tax cuts, those forecasts are likely to remain daunting. The OBR is still likely to say that tens of billions of spending cuts or tax increases will be needed in the medium term even if debt is only to be stabilised.

The chancellor must make two big judgments. First, what set of fiscal rules or targets will he say he is embracing? We have all focused on one possible target: that debt should be stable or falling within five years. That seemed both the most likely interpretation of what Kwasi Kwarteng, his predecessor, was implying he would aim for, and a minimal condition for sustainability. But it is both poor as a rule and inadequate by itself. Debt needs to be put on a sustainable footing, which is not measured by what is happening in any one year. And having that rule alone encourages cuts to investment spending — cuts which are often the easiest politically and the most damaging economically. The chancellor would do well to incorporate a measure of the current deficit in his fiscal targets, as was indeed legislated by Rishi Sunak earlier this year.

Second, what does he actually need to do? Suppose the OBR still does have his targets being missed by multiple tens of billions. The chancellor would then have two broad sets of choices.

He could announce immediate spending cuts or tax increases to come in during the next fiscal year. That is clear, credible and might reassure the markets. But in the context of huge uncertainty it might involve overshooting what turns out in the end to be needed. It could impose unnecessary pain. Big swings in fiscal policy every time we get new economic news is not likely to be anything close to optimal.

So, he could instead choose to say that he will raise taxes or cut spending in three or five years’ time, or that he will wait for uncertainty to resolve itself before making firm decisions. That could meet the letter of any forward-looking fiscal rule. But who is to believe such promises? Not least in the context of the current opinion polls they might look close to meaningless without action up front. The markets, wary of UK fiscal incontinence, might — on Halloween — be spooked.

Ideally, we would be able to use our credibility to leave ourselves some flexibility. The mess that has been made of economic policy over the past few weeks means that credibility is in short supply. More painful and immediate spending cuts or tax rises than might otherwise have been required could well be the price we still have to pay.

This article was first published in The Times, and is reproduced here with kind permission.