Interest, Inflation, Incentives and Keynes (Part 2)

By Dr Ian Jackson

University of Wolverhampton

On the 27 October 2021, Rishi Sunak the Chancellor of the Exchequer delivered one of the most important UK Budgets in peacetime.  Following the steepest decline in UK output for 300 years in the second quarter of 2020 (as a result of the national lockdown), this package of policies had to provide the correct balance of economic incentives and prudent finances to stimulate the UK economy going forward.

By way of context, economic forecasts suggest that the UK Economy will continue to recover strongly and grow by 6.5% in 2021.  The successful vaccination programme has provided a significant boost to economic confidence or what John Maynard Keynes called “animal spirits” that is where decisions are made spontaneously.  Hence, the removal of virtually all the pandemic-related restrictions has resulted in higher demand as the economy has generally bounced back.

However, there are sizeable problems to consider, too.  Supply-side complications have created shortages in many sectors as a result of the different trading regimes post-Brexit and also there are labour scarcities in areas such as distribution.  In addition, there are significant increases in energy costs and all of these factors have resulted in higher price inflation, which is forecast to be 4.4% next year at least.  This means interest rates are expected to rise in 2022 to curb inflationary pressures.

Notwithstanding, to stimulate the UK economy, the Chancellor has announced an increase in public expenditure amounting to £22.9 billion a year by 2026-27.  This means that discretionary spending by the government will reach 41.6% of Gross Domestic Product (GDP) an increase from a pre-pandemic level of 39.8% and to an amount not seen since the late 1970s before the election of Margaret Thatcher as Prime Minister.

To help pay for this increased spending, there will be a further net tax rise of £16.7 billion a year by 2026-27.  This figure is additional to the £31.5 billion increase in corporation and personal taxes announced in the March 2021 budget.  This takes the tax burden to 36.2% of GDP, which is the highest since the early 1950s when Winston Churchill was Prime Minister.

However, Paul Johnson of the Institute for Fiscal Studies claims most of these policies choices are unrelated to the pandemic.  These policies are likely to be the Chancellor responding to longstanding gaps in public finances and chronic underfunding of health and social care by raising taxes, which few of his predecessors would have dared to do even during the Financial Crisis of 2007-08. 

While Keynes was a pragmatist, his vision for expansionary policies were motivated to help in times of economic crisis.  He advocated higher spending and lower taxes in the bad times; not higher spending and higher taxes. Whether Rishi Sunak’s policies will prove effective remains to be seen.

There is an interesting footnote to this Budget, which is the last involving the forecasting of Sir Charlie Bean at the Office for Budget Responsibility (OBR) who is retiring.  Charlie completed his PhD at MIT in the United States under the supervision of Robert Solow, the acclaimed American economist who is now 97 years old. 

Solow, a recipient of the Nobel Prize in Economics and a former Senior Economist to the Kennedy Administration has spent his entire career trying to maintain the importance of Keynesian Economics in times of economic crises.  Through Solow, and other influential economists such as Paul Krugman and Joseph Stiglitz, the ideas of Keynes continue to remain relevant; or least should be.   

Dr Ian Jackson is a senior lecturer in Economics at the University of Wolverhampton Business School.