The cycle will always be with us

Mark Twain is alleged to have read a newspaper account of his own passing and declared ‘the reports of my death have been greatly exaggerated’. That story may well be apocryphal. But it has stood the test of time rather better than Gordon Brown’s now infamous claim as Chancellor that there would never be a return to the economics of ‘boom and bust’.

Of course, the Covid pandemic has thrown everything into turmoil. Rather than asking where we are in the economic cycle, it might be more accurate to say we have fallen off it completely. But once life returns to something more like normal, will the cycle ever become a thing of the past?

Let’s start by exploring what Gordon Brown was getting it. From the election of the Labour government in 1997 onwards, the Treasury has been peddling the view that a fresh approach to policymaking would lead to more stable economic growth. This new framework had three main elements.

First, the Labour government set clearer objectives for both monetary and fiscal policy. These included a new inflation target for the Bank of England, and new fiscal rules for the Treasury. The latter were based on the so-called ‘golden rule’, which is a commitment to balance day-to-day spending with taxation over the cycle and therefore to borrow only for investment.

Second, new institutional arrangements were put in place to achieve these objectives. These included the granting of formal independence to the Bank of England and a much less successful attempt to give the same legal status to the fiscal rules.

Third, there was a marked improvement in transparency, including the publication of the minutes of the Bank of England’s Monetary Policy Committee and the independent audit of key fiscal assumptions. The new Conservative government took this a step further in 2010 with the creation of the Office for Budget Responsibility (OBR).

So, how has this all worked out? Obviously, the ‘boom and bust’ of the economic cycle has not been eliminated. However, that was never quite the aim, or the claim.

Instead, the ambition of Mr Brown and his successors has been to minimise the risk that policy-making itself would trigger booms and busts. It was also meant to increase the chances that the policy framework would help to smooth out the inevitable swings that result from external shocks – such as the Global Financial Crisis, or Covid.

The track record here is mixed. Most economists would agree that the reforms to monetary policy have been a success. There are important credibility gains from having independent central banks set interest rates to hit an explicit inflation target, rather than allowing politicians to manipulate policy for short-term gain.

This is not to say that monetary policymaking is now perfect. A decent case can be made for further reforms, such as paying more attention to asset prices, including house prices, or to monetary aggregates. But the outsourcing of policy to the Bank has brought many benefits.

The outsourcing of economic forecasting and the analysis of the public finances to the OBR has been a good thing, too. Admittedly, these forecasts have not been great, but at least the mistakes have been honest, and the numbers are not being manipulated for political purposes either.

However, attempts to improve fiscal discipline have floundered. The last time the UK government ran a budget surplus was in 2000-01, since when public debt has jumped by more than £1,700 billion (and this mostly before Covid struck).

The principle of the ‘golden rule’ has survived, but it has been hard to put into practice. Numerous iterations of the fiscal rules have either been broken, or abandoned.

To be fair, though, fiscal discipline had to go out of the window during the pandemic. The crisis had shut down large parts of the economy and the government needed to step in to protect jobs, businesses, and incomes, as well as spend whatever it took on health.

Nonetheless, even before the pandemic, public sector spending was averaging around 40% of UK national income. In my view, this was already more than enough to fund good services and infrastructure, and a decent welfare safety net. But politicians inevitably always want to do more,

In addition, the Covid crisis could reverse much of the progress that has been made. The pandemic itself could add as much as £500 billion to public debt. This increase should still be manageable without leading to instability in the future, as long as it is a one-off, borrowing costs remain low, and the economy continues to bounce back.

There are plenty of ‘ifs’ here, but the recent economic news has mostly been good. The current Chancellor should therefore be able to press ahead with plans to wind down financial support that is no longer needed, including the furlough scheme, and allow stronger economic growth to repair the public finances without even more tax increases.

Unfortunately, the apparent ease with which the government has borrowed and spent an enormous amount of money during this crisis has encouraged many to believe that the government can and should continue to do so in future.

This a recipe for a return to the worst excesses of ‘boom and bust’. Indeed, there are early signs of this in the US, where the Biden administration seems determined to pump even more stimulus into an economy that is already overheating.

In the UK too, the Bank of England has does its bit by printing money to buy government debt under the policy of ‘Quantitative Easing’. Again, this made sense when the economy was stuck in recession. But the longer this policy goes on, the greater the risk that inflation takes off and remains high, turning boom into bust once more.

Above all, it is essential to defend the independence of the central bank. Facilitating a temporary increase in government borrowing during a 1-in-300-years recession is one thing. Subverting monetary policy to underwrite a permanent increase in the size and role of the state would be quite another.

The housing market could be a flashpoint here. An extended period of ultra-low interest rates and specific policies to boost demand, including the Stamp Duty holiday, have driven prices up to levels that are surely unsustainable. Anyone still hoping that the economic cycle has been abolished, or that house prices can only ever ‘boom’, may soon be in for a nasty shock.

This article was first published in the Autumn 2021 edition of Property Chronicle‘s quarterly magazine

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