Sunday, June 18, 2017
Austerity has further to run, however you define it
Posted by David Smith at 09:00 AM


My regular column is available to subscribers on This is an excerpt.

Many years ago, as somebody who took a keen interest in monetarism, I was interested to see how a precise economic term – controlling the money supply to keep inflation under control and stabilise the economy – became a catch-all for much more.

So in the 1980s monetarism became, for many people, “the cuts” in public spending, laws to reduce the powers of the trade unions, in fact pretty much anything announced by the Thatcher government.

So it is now with austerity. The 1940s and 1950s version was about paying for an expensive war and accepting the loss of empire, and the years of rationing and other constraints.

21st century British austerity is different and should be easy to define; the process of deficit reduction, mainly by restraining and in some cases cutting public spending but also some tax increases. Even on that narrow definition I have heard some strange contributions in recent days from people purporting to be economists.

Austerity has like monetarism taken on a wider definition. It includes deficit reduction and conventional austerity, which for some takes in the appalling Grenfell Tower fire in London.

But it also includes falling real wages, now lurching downwards at an accelerating pace. It is that, while the jobs being created in Britain are overwhelmingly full-time and permanent, a sense of insecurity stalks the labour market, hence the unusual weakness of wages at a time of near full employment. It is the fact that, eight years on from the financial crisis, interest rates are still at rock bottom and savers cannot get a decent return on their money.

When people say they want an end to austerity, therefore, they want to go back to how things were. For some that would be a return to the time when public spending grew in line, or faster, than the economy as a whole and pay in the public sector grew in line with the private sector average.

For others, it is a return to the days when wages comfortably outstripped, so alongside an inflation rate of 2.9%, which is what we have now, regular pay would be rising at 4.5% or 5%, not the current 1.7%. Similarly, there is a yearning for a time when real interest rates were positive, in other words when rates were – as they usually are – higher than inflation.

There is also an element, for some, of putting an end to Brexit-related economic pain, what I hesitate to call Brausterity, and which is the opposite of the land of milk and honey promised by some.

Gavin Barwell, Theresa May’s new chief of staff, who lost his Croydon Central seat in the general election, blamed austerity and Brexit for the Tories’ poorer than expected showing in the general election. He will be taking that message to the heart of Downing Street.

So what are the prospects for an end to austerity, whether narrowly or broadly defined? Let me start with the broad definition and the big economic news of the week, the fact that three members of the Bank of England’s monetary policy committee (MPC) votes to hike interest rates from the current 0.25% level.
Given that there are only eight members of the MPC at present, until a replacement is found for Charlotte Hogg, this was closer to a hike than anybody expected.

The three, Kristin Forbes (in her last MPC meeting), Michael Saunders and Ian McCafferty were concerned about the prospects for a bigger and more sustained inflation overshoot above the 2% target. They noted that consumer spending was weak – retail sales numbers on Thursday, down 1.2% on the month, showed just how weak – but saw compensating growth in business investment and exports. Their vote for a post-election rate hike broke what had been most people’s sense of the MPC’s position, that rates would stay on hold until there was a pick-up in pay growth.

I cannot argue with their decision to seek to reverse last August’s emergency rate cut. Indeed, in argued strongly in February and May that it should happen. There is a question of timing. Putting up rates when the squeeze on real wages is intensifying looks to be piling misery on misery.

There is no doubt, though, that the whole of the MPC, and not just the three hikers, is getting uneasy about the prospect of inflation going above 3% and staying high for some time. Securing a majority for a hike will nevertheless take time. It will take even longer for a return to positive real rates. Indeed, given that the Bank has indicated that any “gradual” and “limited” move it makes will be to a new norm of around 2% - not to be achieved for some time – a return to the days of above-inflation interest rates is not yet even on the distant horizon.

The same applies to real wages. Unless there is a sudden turnaround in productivity growth, and there is nothing to suggest it, employers will find plenty of ways to restrict pay rises and employees will by and large accept it. There may not be much slack left in the labour market but there is no sense that workers are exercising their bargaining power.

What of the narrower definition of austerity, deficit reduction? The biggest hit the Tories took in the election was from the 5.4m public sector workers, notably nurses, complaining about the absence of pay rises. Nobody’s pay is doing well at the moment but public sector pay, rising at 1% a year, is lagging behind even the very subdued 2.3% earnings growth in the private sector.

Jeremy Hunt, the health secretary, told the NHS Confederation conference on Thursday that he had sympathy with the nurses’ case over pay. I would not be surprised to see the government take a more relaxed approach on public sector pay.

It would be a surprise, however, if there is a more general relaxation in austerity. Policies such as the cash freeze on most working-age benefits until 2020 remain in place and are biting harder as inflation goes up. In practical terms, any relaxation of austerity will be very much at the margins, and mainly forced on the government by the parliamentary arithmetic and an inability to push through unpopular policies. Even before the election the Tories were only promising to balance the books, on their existing plans, by the mid-2020s.

That people are suffering from austerity fatigue, narrowly or broadly defined, is not surprising. None of this was expected to last as long as it did. The emergency interest rates set by the Bank in 2009 were expected to last no more than a year. We thought we had bid farewell to falling real wages three years ago.

In opposition in the run-up to the 2010 election, the Tories looked at models for controlling public spending that would have delivered a short, sharp shock – the Canadian model of 20% cuts was closely examined – but ended up, partly thanks to the demands of coalition government, with a much more gradual approach.

The trouble with gradual is that it takes a long time. And it will not be over for quite a while. However you define it, austerity has further to run.