In 1969, British financial journalist Samuel Brittan published a book called Steering the Economy: The Role of the Treasury. At the time, it was generally assumed that the UK economy could be run and that the Treasury (which was still in charge of monetary policy) was at the helm.
Back then, the Treasury’s macroeconomic model, which calculated national income as the sum of consumption, investment, and government spending, in effect made the budget the regulator of economic performance. By varying its own spending and taxation, the Treasury could push the UK to full employment, real GDP growth and low inflation. Subsequent models, influenced by the monetarist and neoclassical revolutions in economic theory, have since reduced the state’s ability to intervene. However, the idea that governments are responsible for economic performance continues to hold deep.
The recent UK budget announcement is a good example. Presenting its budget to Parliament this month, Chancellor of the Exchequer, Jeremy Hunt, sought to reassure lawmakers that the government is on track to rein in inflation, reduce debt and boost economic growth. He even went so far as to present detailed predictions for each of the next five years. In his own words, “we are following the plan, and the plan is working.” However, it has long been evident that inflation and growth depend on global trends over which the British minister has no control.
The reality is that international finance, technology and geopolitics rule out any possibility of ‘steering’ the UK economy. While these variables were considered stable (or at least predictable) parameters of national policy making until the late 1990s, today they are seen as a source of exogenous shocks -unpredictable or unexpected events- that could potentially ruin any budget forecast.
For instance, no policy maker predicted the global financial crisis caused by the collapse of Lehman Brothers in 2008. Likewise, no one can foresee the repercussions of the recent failures of Silicon Valley Bank and Credit Suisse, especially in an era when in which social networks amplify all the possible effects of each disruptive economic event. And, as heightened geopolitical tensions threaten global supply chains, the models on which policymakers like Hunt rely are becoming increasingly outdated.
In particular, the relationship between fiscal policy and monetary policy is shrouded in mystery. The prevailing economic model assumes that controlling inflation is a necessary and sufficient condition for macroeconomic stability, and that inflation is caused mainly by budget deficits, or by “governments printing too much money.” With that in mind, the government delegated the task of running the economy to the Bank of England in 1997, while the Treasury remained in charge of balancing the budget over a target five-year period, and reducing net debt to a level sustainable.
The combination of Bank of England independence and fiscal discipline was supposed to reassure markets that politicians would not go on a spending spree. But considering that the Bank of England has been printing as much money as politicians want since the covid pandemic broke out, the separation between fiscal and monetary policy has essentially become a fiction, along with the stability and prosperity it is supposed to guarantee.
Hunt should have looked to US President Joe Biden for more creative economic thinking. Biden’s Inflation Reduction Act, which includes $370 billion in clean energy subsidies, is based on an almost forgotten macroeconomic idea known as the balanced budget multiplier: more public spending can be paid for by increases in taxes on the rich. Biden’s stated policy remains to balance the budget, but this strategy would allow him to do so while boosting spending, rather than adopting the kind of austerity policies that British governments continue to pursue.
Biden’s economic policy represents a welcome return to the old Keynesian view that aggregate demand matters. By contrast, Hunt’s plan to boost economic growth depends entirely on remedying so-called structural (or supply-side) deficiencies.
The shocking UK labor shortage underscores the inadequacy of the British government’s strategy. The number of unemployed people stands at 1.3 million, and millions of other Britons of working age are neither employed nor actively looking for work. However, many companies are struggling to find workers, with job vacancies reaching 1.1 million. Hunt’s response is to increase incentives for the “economically inactive” to re-enter the job market. But, in practice, he is encouraging people to apply for jobs that don’t exist.
The reason is that, despite supply bottlenecks in sectors such as retail, hospitality, and agriculture, the economy as a whole experiences a deficiency of aggregate demand. Considering that the British economy has not yet recovered its 2019 level, and that consumption has fallen while the population has increased by 1.7 million between 2020 and 2023, none of this should come as a surprise. However, the latest government budget makes no mention of boosting aggregate labor demand, either on the consumption or investment side.
In late 2020, together with former British Prime Minister Gordon Brown, we proposed a plan whereby the government would guarantee employment and/or training to anyone who could not find work in the private sector, at a fixed hourly wage not less than the national minimum wage. This, we said, would be the fastest way to boost aggregate consumption in the economy without resorting to complicated forecasts about the size of the output gap. As John Maynard Keynes once said, “Take care of unemployment, the budget will take care of itself.”
On the investment side, Hunt announced the creation of 12 investment zones free from cumbersome regulations that supposedly stifle the “animal spirits” of entrepreneurs. However, by concentrating on these supply-side measures, Hunt missed an opportunity to strengthen two publicly funded and fledgling investment institutions: the UK Infrastructure Bank, which was created in June 2021 to provide financing for projects aimed at tackling climate change and supporting local economic growth, and the British Business Bank, created in 2014 to seal the financing gap for small businesses. By improving public investment, the government was able to improve business expectations and divert investment from speculation to critical green energy and regional development projects.
At a time of global turbulence and heightened uncertainty, the main goal of the national budget is not to steer the economy to the point of imagined stability. Rather, policymakers must use fiscal policy to shield the least advantaged from disruptive external shocks and achieve maximum strategic autonomy in a world that is spiraling out of control.
Robert Skidelsky, a member of the British House of Lords, is Emeritus Professor of Political Economy at Warwick University.
