UK austerity budget had ‘massive’ hole that will hurt growth: Michael Saunders

LONDON — UK Finance Minister Jeremy Hunt’s recent budget announcement had a “massive” hole where an economic growth strategy should be, according to former Bank of England policymaker Michael Saunders.

Hunt last week announced a £55bn ($65.2bn) package of tax hikes and spending cuts as he tried to fill a void in the country’s public finances.

It came as the Independent Office for Budget Accountability confirmed the UK economy is already in recession and faces a 1.4% contraction in GDP in 2023, while living standards are set to fall at its fastest pace ever.

Speaking to CNBC on Monday, Saunders – who sat on the Bank of England’s monetary policy committee from August 2016 to August 2022 – said the reduction in trading intensity due to Brexit and lower productivity growth had permanently damaged potential output.

The OBR estimated in May that the UK’s new terms of trade with the European Union, set out in the Trade and Cooperation Agreement (TCA) which came into force on January 1, 2021, will reduce productivity to long term of 4% compared to the previous trajectory had the United Kingdom remained in the EU.

“Part of the reason things are so bad is that potential growth is so low and should be low,” Saunders said.

“That’s why according to the MPC, even though GDP is expected to be slightly lower in the fourth quarter of 2019, they think the economy is in high excess demand, in other words, it’s overheated, even without They believe that the potential growth in production for the next few years will be less than 1% per year.

Essentially, the shock to the economy that caused the inflation was not stronger than expected production or demand, but rather a shortfall in production on the supply side of the economy. , meaning the bar for excess demand that could overheat the economy is much lower.

“The big surprise of the past year is not that the economy was stronger than expected, because it wasn’t, it was that the supply side of the economy was weaker than expected. , with the result that unemployment is lower than expected and domestic inflation pressure is stronger than expected, even though GDP growth has not been stronger than expected,” Saunders explained.

He added that monetary policy must therefore ensure that the economy does not grow faster than its current anemic rate, as potential output growth is low, meaning the government must resort to “little or no growth”. public expenditure or an increase in the tax burden”. if it wants to put its budgetary situation back on a sustainable path.

“If you think about this previous output trajectory, the MPC and OBR think potential output is lower in Q4 2019, but… over three years at the pre-pandemic pace, you would expect potential output to grow probably 4.5%, something like 1.5% per year, so that’s that shortfall from what was a pretty miserable trend anyway,” Saunders said.

“We’ve spent most of the last 10 years saying that potential output growth is weak because look how far below the pre-GFC (Global Financial Crisis) trend we are, and now we’ve even fallen below the post-GFC trend.”

Hunt’s budget plans include around £30billion in public spending cuts, the biggest of which have been heavily delayed beyond April 2025, which is after the country’s next general election.

“I thought the fall statement just had a huge hole where a long-term growth strategy should have been,” Saunders told CNBC by phone.

“Delaying government spending cuts isn’t really about trying to improve long-term growth prospects, it’s just about trying to limit the pain of adjustment to weak potential growth prospects.”

A UK Treasury spokesperson was not immediately available for comment when contacted by CNBC.

He noted that cuts in public investment, which constituted a substantial part of the cut in government spending, “will likely worsen potential output growth”, and pointed to OECD studies that suggest a large gain public investment for potential growth.

A 2016 OECD report found that public investment “has a positive effect on long-term growth and labor productivity” and can also “accelerate the speed of convergence of catch-up countries”.

“If you want to do fiscal consolidation, doing it by cutting public investment is the least useful thing you can do to try to boost potential output,” Saunders added.

His comments were echoed on Sunday by Britain’s biggest business lobby group, the Confederation of British Industry. Chief executive Tony Danker told the BBC that Hunt had apparently prioritized stability over growth, but that without higher growth the country would not be able to pay its rising health and healthcare costs. social protection.

Danker told the BBC the autumn statement was “all about tackling inflation and getting the government’s budget in decent shape and that needs to be done”, but added that “there was really nothing there that tells us the economy is going to avoid another decade of low productivity and low growth.”