We can but pray for animal spirits if Chancellor puts up taxes

Few Chancellors have ever been subjected to so much thoughtful criticism in the run-up to a budget. Economic commentators and analysts, serious bankers and businessmen plus – mainly in private – some of his own backbenchers: all of them agree that he would be wrong to put up taxes. There seems to be only one source of comfort for him; the old adage that a popular budget will always become unpopular six months later, and vice versa. Rishi Sunak must hope that this is still true.

Yet there is one crucial point. In itself, the tax argument is a sideshow. After all, even if Sunak were to announce increases, immediate and future, of up to £10 billion, that is less than half a per cent of GDP. Much bigger issues are in play, and they have one point in common. The commentariat may be united in opposing tax increases. On three other vital questions, there is no unanimity and a good deal of fascinating agnosticism.

The first unknown is the bond market and inflation. The US has elected a spendthrift President who will be abetted by a profligate Congress. In the early 1960s, there was a notorious football pools winner, Viv Nicholson, who declared that she would “spend, spend, spend.” She did just that, until the cash ran out. Although Joe Biden may not know it, he takes after her. America is already responsible for just over thirty per cent of the world’s sovereign debt. The Democrats on Capitol Hill and in the White House propose to add another three per cent, and that may prove to be an underestimate. In one respect, the US can get away with this. The world has not lost its appetite for greenbacks, although it is surprising that the gold price is not higher. But the markets are uncomfortable. Investors appear to believe that with the Covid vaccine programme gaining momentum, world economic growth is set for a fast recovery. Such rapid growth is always likely to lead to inflation, even without a huge fiscal stimulus. So it is likely that America will experience rises in interest rates and higher inflation, both of which are infectious. There is no inoculation programme which can immunise other countries.

The Americans have a further problem. In the 1980s, President Reagan ran what appeared to be lax fiscal and monetary policies: almost a prototype for modern monetary theory. But this did not matter. There was enough spare capacity to absorb the new money, in jobs, output and investment. That is no longer the case. Although there is spare capacity, the obstacles to its deployment are cultural rather than economic. The rust and opioid belt, so eloquently described in Hillbilly Elegy; several inner cities, as shown in The Wire – none of those areas will be readily responsive to a macro-economic stimulus.

This helps to explain the Chancellor’s apparent enthusiasm for fiscal rigidity. Up to now, when it comes to marketing UK gilts, the watchword has been long and low: distant redemption dates and a miniscule coupon. As the Treasury will want that to continue for as long as possible, this is no time to spook the bond markets, one set of economic observers who will not complain about a hint of austerity.

That brings us to the second great unknown. It might seem banal to mention this goal, which does not make it easier to achieve. The Chancellor would like to return the economy to normal. That has obvious implications for the public finances, but there are even bigger difficulties. Although they are not – yet – on an American scale, some of them are becoming cultural rather than just economic. Whether it will be furloughing or school meals spilling over into the holidays, a large number of people have become dependent on the state, and a lot of them are enjoying it. Some of them will resent any return to normality. On Wednesday, it seems that Sunak will announce further measures to ease the pain of Covid. Even if they will not solve all the problems of the High Streets and those who used to work there, the individual measures will all be desirable.

The danger is that they will also add to the impression that one of Ronald Reagan’s nostrums is now out of date. Never feel more sceptical, he would say, than when you hear an official proclaim that: “I’m from the government and I’m here to help you.” Of course, the government has a Covid-related role, but as a casualty-clearing station, not a way of life.  Recovery depends on a twin revival: markets and animal spirits. Without them, no amount of government intervention will succeed.

That brings us to the third unknown, which was literally unknown until 2009: quantitative easing (QE). It has now reached almost £900 billion, around forty-five per cent of GDP. Imagine Margaret Thatcher’s reaction if she had been told that the government proposed to print that amount of money. Yet she may have been wrong. The currency has not collapsed. Inflation has not caught fire, and the economy has been sustained. Mark Carney estimates that without the post-2009 QE, GDP would have been eight per cent lower and unemployment one and a half million higher. That pales into insignificance in comparison with post-Covid QE. It is easy to describe its effect. It has saved the British economy. But where do we go from here?

Years ago, there was an American quiz show famous for the $64,000 question.  Now in the UK, we are approaching the trillion pound question, but there is a difference. Some American contestants gave the correct answer. In the UK, nobody seems to know the answer to the huge question: how long can this go on?

As the economy recovers, one would hope that further QE ceased to be necessary. But what is to be done with the existing holdings? There is an obvious solution. After all, QE means that the government owes itself a debt. So why not cancel it? If this were the Treasury’s longer-term strategy, it would be wise to keep it secret. The bond markets’ confidence would not be boosted. Would you trust a government that proposed to write off a trillion quid? Yet let us assume that we grow our way out of the Covid recession, restore stability, manage to bring the annual PSBR below the annual growth rate, and can look the bond dealers in the eye. What then? There are bound to be mice in the Bank of England. Let them find their way to the drawer where the QE certificates are kept, and use them to line their nests. Why not?

In the meantime, we have Wednesday’s budget. If the long-term aim is to restore confidence, there would seem to be no case whatsoever for fiscal tightening. The sums that the likely increases might raise would hardly transform the nation’s finances, and they would send all the wrong signals. That is especially true of corporation tax. Certainly, if various delivery firms and coffee-bar chains are avoiding tax, block the relevant loop-holes. But we should be boasting about the UK’s low rate of business taxation, not trying to undermine that competitive advantage, especially while adjusting to Brexit. Yet it seems that the Chancellor has chosen his course. If so, we can only hope that animal spirits and market revival are undaunted.