4.2 Pandemic and Truss Flashcards
What was the effect of the pandemic?
Public sector deficit rose massively, forecast to end up higher than predicted in March 2020 - response to COVID
Predicted level was 50-60bn, actual outturn was about 320bn
There was a massive decline in GDP and slow recovery - anticipated permanent negatie effect of 2% GDP lost forever, on top of Brexit effects - slow growth remains
March 2020 forecast was 100-104
Actual march level was around 75
What was the effect on the Debt/GDP ratio
Expected to top out at about less than 100% of GDP and then largely stabilise and fall gently
- No political discussion of debt ratio, no talk of precipice
- Reason deficit falls and debt/GDP ends up stabilising is tax burden is rising (expenditure largely flat)
- In 2010, austerity all about reduction in expenditure
Outturn around 90%GDP, estimated march 2020 forecast about 75%GDP
By the end of 2021 and 2022 the UK was expected to head towards an improved fiscal position, however the Russian invasion of Ukraine occured February 2022 - energy price surge and further shock to AS
What was the ambition of Trussonomics?
Challenged economic fiscal orthodoxy
- Sacked treasury official
- Undermined BofE independence
- Side lined OBR
Large expenditure increase - energy price guarantee
Large tax cuts
Financial times:
- Biggest package of tax cuts in 50 years
- NO effort to make public finance numbers add up
- Seems to borrow large sums at expensive rates - but government on unsustainable rising path of debt and hope we get better growth
What is the effect of tax cuts
- Short run effect on GDP
- Dont affect long run growth in standard economic model
- Short run multiplier - long run multiplier is 0
Remember economic backdrop is that there will be a large negative shock to the economy, as government expenditure is decreasing on top of an increase in deficit
What was the effect of the tax cuts?
Previous mini budget forecast was around 36% GDP, post mini budget forecast started to fall to 35%GDP
Remember if growth < interest rate, and country runs primary deficits - debt ratio increases over time
This means deficits rising, growth was slowing and interest rates were rising
Borrowing rates:
The 2022-2023 OBR forecast borrowing rates were around £99bn, the actual rate about £200bn - nearly £100bn higher
2026-27 around £100bn forecast, £70bn that OBR original forecast.
Forecast PSND:
- Forecast declining between 83-85% GDP
- After Truss forecast to continue rising by around £60bn in 2026-27 - rising up to 95%GDP
The result was obvious - fiscal path was unsustainable and tax cuts would never deliver faster growth
Exchange rate:
Was falling but stable at around 1.15, fell to about 1.075
5 year UK government bond yields:
- Rising, stable at around 3%, rose to 4.5%
What is New austerity;
Budget undoes the tax gamle, raises taxes
- Reduces expected path for deficit, helps reduce expectations of future interest rates:
PSNB much lower than expected - about 2%
Bank rate also much lower than expected - about 2%
Interest on bonds fell back to original rates - fell about 1%
Tax as a share of national income forecast to increase above 37% - forecast about 36%
This largely put us back to where we began pre Truss however,
debts barely on falling path - estimated falling by £28bn margin in 3 years time, instead falling by £9bn margin over 5 years time
What were the expenditure plans in the new austerity model? What is the estimated pattern for this?
2 years of expenditure, cuts to spending
- mainly on schools, NHS, overseas aid, provision day-to day spending totals
Spending about £1bn 2022-2023
7bn 2023-2024
8bn 2024-2025
- 6bn 2025-2026
-14bn 2026-27
- 21bn 2027-2028
What is the economic reason for this?
- Economic - Backloading
The IS-LM demonstrates the effect of fiscal policy - a cut in G decreases GDP growth in the short run, not the long run
- Shift IS model out to IS2
- Reduces interest rates permanently. Investment and consumption depend on expectations of future interest rates, leading to IS curve to move back down towards IS1
- Decline in growth not as severe as suggested
This is called backloading - delay in negative eeconomic effect of a decrease in G, hoping for positive economic effect of expectations now
What is the political reason for this pattern?
Economy
- Governments want to be re elected and so incentivised to make the economy look good
Fiscal policy increase to achieve this, then cut spending after election so effect gone by the time the next election comes around (multiplier effect in play)
In november 2022 economy was in recession, conservatives behind in polls
- “Im afraid to tell you theres no money left” likely note left by outgoing conservative administration to incoming labour in 2024
Conclusion
Fiscal policy where economics and politics clash
Austerity 1: political desire hidden behnind the economy need
Austerity 2: political and economic need
