Sunday, November 06, 2022
A triple whammy of rate rises, tax hikes and spending cuts
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thetimes.co.uk This is an excerpt. Not to be reproduced without permission.

Some of you, perhaps not that many, will remember the double whammy. It was used quite effectively by the Tory party 30 years ago, enabling them to win the 1992 general election, against the odds. The double whammy, illustrated with a picture of a very large pair of boxing gloves, were the higher taxes and higher prices that would apparently be the consequence of a Labour government.

These days, a double whammy does not really capture it. The economy is facing a triple whammy of higher interest rates – with another big hike duly delivered by the Bank of England on Thursday – tax increases and spending cuts, of which we will learn more in the November 17 autumn statement. If you want to include higher prices in the mix, we could even make it a quadruple.

Items two and three of the triple whammy, higher taxes and spending cuts were confirmed by Jeremy Hunt, the chancellor, in impromptu remarks at the Sunday Times Business party a few days ago. Businesses and individuals would face higher taxes, he said, and there would be spending cuts across the board. This was not, he said, Treasury expectations management ahead of a big fiscal event, with warnings that turn out be unjustified. He meant it.

The thing about this triple whammy of higher interest rates, tax hikes and spending cuts is that it comes at a time of high inflation, public finances which are shaky enough to concern the Office for Budget Responsibility (OBR) and, by extension, the chancellor and prime minister, but also at a time when the economy is, according to the Bank, already in what could be a long-lasting, if relatively shallow, recession.

Most of the readings we have for economic activity, such as the purchasing managers’ surveys that measure business-to business activity, are at levels that would normally be consistent with cuts in interest rates, not hikes. You do not have to be a Keynesian to think that tax hikes and spending cuts are not what you would normally be doing at a time of economic weakness, The triple whammy pay be what guarantees the recession.

There’s a health warning to be attached to the Bank’s long recession forecast, which that it is conditioned on market expectations for interest rates that may not be fulfilled. But that caveat may be offset by the fact that this monetary tightening is to be accompanied by a fiscal tightening, which is not something that was on the cards even a few weeks back.

A short time ago, we had a prime minister and chancellor determined to avoid recession and go for growth, even by risking the public finances and more prolonged inflation. Now we have a prime minister and chancellor who are not prepared to take risks with the public finances, agree with the Bank that getting inflation down has to be a priority, and are prepared to live with the consequences if they mean that the economy goes into recession. Confused? Perhaps you should be.

The lurch began, it should be said, before Rishi Sunak became prime minister, when Jeremy Hunt junked most of his predecessor’s maxi mini budget and limited the energy price freeze to six months. It was a triumph of Treasury orthodoxy. The question now is how much further it goes on November 17. Two chancellors are running the country, one ex, one current, and even I would conceded that you can have too many of them

There is a template for what Hunt and Sunak are doing, and it goes back 40 years or so. When Margaret Thatcher was first elected in 1979, it was with a determination to bring down inflation and reduce public sector borrowing, the budget deficit, even if that would be painful. The 1981 budget, which raised taxes significantly in the teeth of a recession, was its apogee.

That was the budget which attracted the critical letter from 364 economists, which remains a reference point today. Even recently, some people were saying that economists would be proved as wrong on the “Trusseconomic” unfunded tax cuts as the 364 were in 1981. But no, the majority of economists were proved to be exactly right, as they usually are, particularly when I agree with them.

The hairshirt of 1981 was uncomfortable but it did not stop Thatcher from winning a second general election victory, admittedly against a divided opposition, two years later. By that time inflation had come down sharply and the economy was recovering well, having begun to do so around the time of that 1981 budget. That and victory in the Falklands war saw her home.

This time looks different. I noted last week that most economists expect only a mild recession next year but that we should expect something scarier from the Bank. So it proved and however you cut it, 2023 is looking like a pretty grim year, exacerbated by the impact of the triple whammy.

What could limit the damage? Financial markets have become obsessed with “the pivot”, the point at which central banks, particularly America’s Federal Reserve, realise that they have done enough in raising interest rates, so that the next move will be downwards. We are not there yet, particularly in America, but we should be there in the early months of next year in the UK, particularly when it becomes clear that inflation is on course to head down quite sharply. Some are calling Thursday’s increase in rates by the Bank a “dovish” hike, in that it is possible to see both a slower pace of rate rises from now on and an eventual light at the end of the tunnel.

Full employment, or at least a very low unemployment rate (partly due to a smaller workforce) is another positive. It means that in the housing market we should not see the forced selling that could otherwise precipitate a price crash. For the wider economy, still suffering from labour shortages, it should mean a decoupling between growth and unemployment. In a mild recession, unemployment might not rise by much, if at all.

There is also the factor that at one time was going to be the story of 2022, the unleashing of the involuntary savings built up during the pandemic when people could not spend on the things they normally do. Those savings, of which a central estimate is about £200 billion, are still waiting to be spent. When those who have them feel confident enough to spend, they could make a difference.

Those are potential offsets but this triple whammy still makes me feel uneasy, even if there is no serious alternative to tackling inflation and fixing the public finances. David Owen, a veteran City economist now with Saltmarsh Economics points out that during the period of Austerity 1.0, under David Cameron and George Osborne, investors never questioned the UK’s long-term debt sustainability. The first austerity occurred alongside low inflation and near-zero interest rates.
Now that there is an inflation problem as well as a perceived debt problem things are more uncomfortable, particularly for a government that has ambitions to sort out some of the UK’s deeper problems.

As he puts it: “The combination of a tighter fiscal policy and tighter monetary policy is not the right mix of policies to put forward to try and address the UK’s fundamental problems of a lack of investment and low productivity growth. Indeed, following the EU referendum of over six years ago, we have yet to see the government really put forward a joined-up policy to address all such issues. That will be the true test of the new PM and his chancellor, not whether they have filled what is something of an imaginary hole in the public finances.”

It will indeed. We were in the frying pan when Liz Truss was prime minister. We are still not out of the fire.