Everybody’s talking about the cost of living crisis. Which poses the question: why are we not therefore also talking about recession? The Treasury’s regular survey shows that private sector forecasts for real GDP growth this year range between 3.3 and 5.7 per cent, with a median of 4.1%, and the OBR is forecasting 3.8% growth. How can we reconcile this with Bank of England Governor Andrew Bailey’s talk of “an historic shock to real incomes” and with the OBR and private sector forecasters predicting a fall in households’ real incomes? It’s certainly not because fiscal policy will support demand. It won’t. It will tighten this year: the OBR foresees cyclically adjusted net borrowing falling from 6.1% of GDP in 2021-22 to 4.4% in 2022-23 thanks to higher NICs and real-terms cuts to
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Everybody’s talking about the cost of living crisis. Which poses the question: why are we not therefore also talking about recession?
The Treasury’s regular survey shows that private sector forecasts for real GDP growth this year range between 3.3 and 5.7 per cent, with a median of 4.1%, and the OBR is forecasting 3.8% growth. How can we reconcile this with Bank of England Governor Andrew Bailey’s talk of “an historic shock to real incomes” and with the OBR and private sector forecasters predicting a fall in households’ real incomes?
It’s certainly not because fiscal policy will support demand. It won’t. It will tighten this year: the OBR foresees cyclically adjusted net borrowing falling from 6.1% of GDP in 2021-22 to 4.4% in 2022-23 thanks to higher NICs and real-terms cuts to departmental spending.
The OBR foresees the household savings ratio falling to 3.1% in 2023, its lowest rate in over 60 years. And it expects households to be net borrowers throughout the next five years, something unprecedented since current data began in 1987.
In part, this is because it expects us to run down some of the savings we built up during the pandemic. But of course, not all of us did build up savings: those on low incomes or who lost their jobs never got the chance to do so. The OBR expects these to borrow more. Granted, it doesn’t see aggregate debt rising much more than post-tax incomes over the next five years, but the debt is likely to be concentrated among those in poor financial health to start with.
What the OBR expects is, therefore, a form of what Colin Crouch called privatized Keynesianism (pdf). Government borrowing won’t support demand much, but – it believes - private sector borrowing will.
In three respects, however, this is inferior to conventional Keynesianism.
One is that we cannot wholly rely upon it happening. Perhaps the pandemic has thrust us into more frugal habits, such as eating and drinking at home with friends rather than going to pubs and restaurants. Perhaps the fear of Covid will keep us out of shops and pubs. Perhaps we’ll fear that the squeeze on real incomes will be long-lasting – and if our permanent income falls, so too should our spending. And of course, some of us are credit-constrained: who’ll lend to a single parent on a zero-hours contract?
In this respect, the prospects for privatized Keynesianism are less good than they were in the first iteration of that project, the 1980s. Back then household borrowing rose strongly, supporting demand. But things were different then. Years of credit regulation meant that households began the 1980s with debt below desired levels. We cannot say the same today. And borrowing then was based on those who kept their jobs being (reasonably) optimistic about their future incomes. But there’s a difference between borrowing because you expect your incomes to rise, and borrowing to buy necessities – one of them being banks’ willingness to lend to you.
Secondly, privatized Keynesianism is simply less efficient as a way of transferring real resources from the future to the present. Even after the recent rise in gilt yields, the government can borrow at real yields of less than two per cent – which means that for every £100 it borrows for 20 years it will have to repay only £65. Households, however, have no such luxury. Even the best personal loan rates are only marginally negative in real terms – and of course not everybody is creditworthy enough to get these. Somebody who responds to the income squeeze by cutting their pension contributions will miss out on a real return of probably 3-5% a year. And of course, there are those who’ll have to resort to loan sharks at usurious rates.
If you believe that government borrowing imposes a burden upon future generations, you much think this is even more true of household dis-saving. Affluent households who cut their pension contributions or bank balances will leave less to their children. And stressed-out lower income parents will be less able to buy books, musical instruments or school trips for their children, thus impairing their education and future earnings.
Which takes us to a third problem. Privatized Keynesianism increases financial fragility. Households who have run down their savings or built up debts are more likely to cut their spending when made unemployed, thereby exacerbating the next recession. Banks who extend their balance sheets are more likely to restrict credit in bad times. And of course, even if there are no adverse macro-level effects of increased debt, individuals who have run up debts face stress, uncertainty and violent threats from loan-sharks.
All of which poses the question: why would anyone prefer privatized to government Keynesianism?
A good answer is that if you really believe that households will borrow a lot so that demand grows well then conventional Keynesianism is not only unnecessary but dangerous, as it would add to inflation.
But there are less good answers. One is that the government is making a fetish of the public finances, and is ignoring the fact that private borrowing to support demand is more dangerous than public borrowing.
Even nastier than this, however, is another possibility. In our stagnant economy, there are few profitable opportunities, so the government needs to create some. And one way of doing so is to create conditions in which households are forced to borrow at high rates. We have a government for loan sharks.