Don’t panic about the UK’s high debt

Last week the Prime Minister focused on ‘build, build, build’. For the Chancellor, it was ‘jobs, jobs, jobs’ on Wednesday as he outlined an ambitious and interventionist suite of measures to prevent a rise in unemployment. These measures are estimated by the Treasury to be worth up to £30 billion.

The last time the UK had high unemployment was in the early 1980s. The labour market was very different then – it was often described as sclerotic, with high unemployment also the consequence of a necessary restructuring of the economy. Today, however, the labour market is much more flexible and the deep recession and threat to jobs is from an economic shock. That is why the Chancellor should feel confident that his measures will be effective in limiting the rise in unemployment. His focus is now on ensuring the recovery continues, as well as specific measures aimed at the young and sectors in difficulty.

The threat to jobs is likely to be seen in three waves: first, as the Government’s existing schemes are phased out; second, as the vaccine gap prevents a number of sectors from returning to normal, with social distancing in place and with people reluctant to venture out and spend; and a third possible wave as firms emerge from this crisis with high debt that forces them to deleverage and not invest and recruit staff.

On Wednesday, the Chancellor tackled these first two waves, and he has made clear that he will address the third area later. This third wave may require a coronavirus fund to convert debt into equity.

At the beginning of his statement, the Chancellor highlighted the scale and swiftness of the Covid recession, with the economy contracting in two months by 25 per cent, having previously taken 18 years to grow by this size. The unlocking of the economy is already contributing to a significant, and swift, economic rebound. The same is evident in many other countries, too.

We should be optimistic about growth prospects over the remainder of this year and the next. But while many sectors will rebound quickly, areas like the arts, the creative industries, hospitality and tourism will continue to struggle. During the vaccine gap phase it will be hard for these sectors to return to normal.

The Chancellor’s measures were aimed at these areas. Help for the arts sector was announced at the start of this week and tax cuts were unveiled today to help other sectors. These measures suggest the economy will not return to its pre-crisis level until the end of next year. Unemployment will likely be higher too, even taking into account today’s welcome measures.

How will we pay for this crisis? The UK will certainly emerge from this period with a huge debt to GDP ratio, which will be above 100 per cent. Such a high stock of debt leaves the UK vulnerable to future economic shocks, and so it is necessary to have a clear, credible plan to reduce this debt overhang over time.

But there is no need to panic just yet. We are in an environment of low inflation, rates and yields, which has reduced debt servicing costs considerably and is creating a strong appetite among investors to buy government debt. The UK has ruled out austerity. Today the Chancellor announced specific tax cuts. In the future, however, he also needs to rule out significant tax increases. Instead, his focus should be on stronger economic growth to reduce the debt to GDP ratio.

Monetary policy will remain supportive and accommodative. That means short-term policy rates will remain low for some considerable time. The Bank of England recently announced further quantitative easing, of £100 billion to £745 billion. The Chancellor’s latest measures should not directly impact the immediate outlook for monetary policy and provide further evidence that in this crisis, much of the policy stimulus has been carried out by fiscal policy.

Today’s measures are welcome, but what is needed is a three arrow approach to policy – and the Government needs to aim for a bullseye with each shot.

The first arrow is credible fiscal activism. This not only justifies fiscal policy doing more of the heavy economic policy lifting in this crisis, but it also necessitates a credible plan of action to reduce the ratio of debt to GDP gradually over time. Creating fiscal space will be an important feature of this and it should have tax cuts as its main feature, alongside reducing debt to GDP steadily over time.

The second arrow, linked to the first, is that consistency is needed between monetary and fiscal policy. I would advocate a new Bank of England mandate centred on a money GDP target as part of this, as I argued in a recent Policy Exchange paper, A pro-growth economic strategy.

The third arrow is supply-side measures, including incentivising the private sector to invest, innovate and grow.

A decade ago the focus was on ‘cut, cut, cut’ as austerity occupied centre stage. That was wrong then and it would be inappropriate now. Instead the focus has rightly moved to ‘build, build, build’ and to ‘jobs, jobs, jobs’.

Gerard Lyons is Senior Fellow at Policy Exchange and former chief economic adviser to Boris Johnson