LONDON — U.K. Finance Minister Jeremy Hunt’s recent fiscal announcement had a “massive” hole where an economic growth strategy should be, according to former Bank of England policymaker Michael Saunders.
Last week, Hunt announced a ?55 billion ($65.2 billion) program of tax hikes and spending cuts as he attempted to plug a gap in the country’s public finances.
This came as the independent Office for Budget Responsibility confirmed that the U.K. economy is already in recession and faces a 1.4% contraction of GDP in 2023, while living standards are expected to fall at their sharpest rate on record.
Speaking to CNBC Monday, Saunders — who served on the Bank of England’s Monetary Policy Committee from August 2016 to August 2022 — said reduced trade intensity due to Brexit and lower productivity growth had permanently damaged potential output.
The OBR in May estimated that the U.K.’s new terms of trade with the European Union, set out in the Trade and Cooperation Agreement (TCA) that came into effect on Jan. 1, 2021, will reduce long-run productivity by 4% relative to the previous trajectory had the U.K. remained in the EU.
“A part of the reason why things are so bad is because potential growth is so weak and is expected to be weak,” Saunders said.
“That’s why in the MPC’s view, even though GDP is expected to be slightly below 2019 Q4, they think the economy is in significant excess demand, in other words has overheated, even with no growth. They think potential output growth for the next few years will be less than 1% per year.”
Essentially, the shock to the economy that is driving inflation has not been stronger-than-expected output or demand, but rather a shortfall in the economy’s supply-side production, which means the bar for excess demand to overheat the economy is much lower.
“The big surprise over the last year is not that the economy has been stronger than expected, because it hasn’t been, it’s that the economy’s supply side has been 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 therefore has to ensure that the economy doesn’t grow any faster than its existing anemic rate as potential output growth is weak, meaning the government has to resort to “little or no public spending growth or a rising tax burden” if it wants to return its fiscal position to a sustainable path.
“If you think about this previous output path, the MPC and the OBR think that potential output is lower than 2019 Q4, but … over three years at the pre-pandemic pace, you’d expect potential output growth of probably 4.5%, something like 1.5% per year, so it’s that shortfall relative to what in any case was a pretty miserable trend,” Saunders said.
“We’ve spent most of the last 10 years saying that potential output growth is weak because look how far we are below the pre-GFC (Global Financial Crisis) trend, and now we’ve fallen below even the post-GFC trend.”
Hunt’s fiscal plans include around ?30 billion in public spending cuts, the deepest of which were heavily backloaded beyond April 2025, which would be after the country’s next general election.
“I thought the Autumn Statement just had a massive big hole where a long-term growth strategy should have been,” Saunders told CNBC via telephone.
“Delaying the public spending squeeze isn’t really about trying to improve the long-term growth outlook, it’s just about trying to limit the pain of adjusting to a low potential growth outlook.”
A spokesperson for the U.K. Treasury was not immediately available for comment when contacted by CNBC.
He noted that cuts to public investment, which constituted a substantial portion of the government’s spending squeeze, will “probably make potential output growth worse,” and highlighted OECD studies that suggest a broad payoff from public investment for potential growth.
An OECD report in 2016 found that public investment “has a positive effect on long-term growth and on labour productivity” and can also “increase the speed of convergence of catching-up countries.”
“If you want to do a fiscal consolidation, doing it through cutting public investment is the least helpful thing to do in terms of trying to boost potential output,” Saunders added.
His comments were echoed on Sunday by Britain’s largest business lobby group, the Confederation of British Industry. Director-General Tony Danker told the BBC that Hunt had seemingly prioritized stability over growth, but that without higher growth, the country would not be able to afford its rising costs of health and social care.
Danker told the BBC that the Autumn Statement was “all about fighting inflation and getting the government budget in some decent shape and that does need 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.”