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Jeremy Hunt has a choice between politics and economics

Jeremy Hunt has a choice between politics and economics

When you’re in the budget hole, stop digging. This has been the position Jeremy Hunt has adopted since his appointment as chancellor four weeks ago.

Since the September “mini” budget, when financial markets lost faith in the health of the UK’s public finances, it was clear that the state would pay for this mistake. The average government borrowing cost rose from 1.1 percent at the start of the year to 3.8 percent this week.

The vast majority of this increase reflects global forces – rising inflation and rising interest rates – but markets are watching. They will be more accurate in evaluating budget plans in the UK than in most other countries, and Hunt knows he must make a compelling case. In Thursday’s fall statement, he needs to show sustainable public finances, credible policy measures, and borrowing and debt that will be resilient to some additional economic shocks. This is why the chancellor frequently talks about difficult decisions that are “shocking to the eye”.

One of the most important of these options is the balance that must be struck between tax increases and spending cuts. He will almost certainly choose the relatively easy options to allow inflation to pull people into higher tax brackets, rather than set rates, and cut some investment spending – set to be at historically high levels – rather than putting pressure on public services too much.

Those are in the bag, but they won’t be enough to fill the financial gap, which Treasury insiders have estimated at just over £50 billion a year by 2027-28, when the economy should return to business as normal.

The remaining actions will reveal whether Hunt prioritized good economics or smart policy in this statement. Economics suggests it must take on the extra pain, laying out immediate spending cuts and tax increases similar to the programs Norman Lamont and Ken Clark pursued in the early 1990s.

It won’t necessarily deepen the next recession, as the Bank of England is there to calm demand and offset the fiscal contraction with lower interest rates than they might otherwise be.

With interest rates at 3 per cent, the Bank of England has room to loosen monetary policy if needed because the immediate tightening of the budget is aggressive enough. Let’s be clear. The Bank of England believes a recession is necessary to tame inflation, but need not be deep, as long as companies do not seek to raise prices excessively and the demands of workers moderate.

In this scenario, by the next election (which should be called by late 2024) inflation will likely be under control and there will be room for a period of faster-than-normal growth. Loading up the task of budget reform would have been a necessary step, making UK economic policy immediately credible. There may be some other gain to be enjoyed from financial markets that are positively looking cautiously, further lowering borrowing costs.

The problem with front loading is that it’s a terrible policy. Immediate tax increases and spending cuts will not be popular with Conservative MPs and across the country. A sort of public finances would put the UK in a better position during the second half of the decade, but that is when Labor is most likely to take power.

Therefore, there is a risk that Hunt will load tough decisions into 2025 and beyond and reduce the immediate political pain of fiscal consolidation. If Labor wins the next election, it inherits weak public finances and huge demands for better public services.

Financial markets might well think that this government’s pledge that the next government will manage sustainable public finances is not credible and, again, punish the UK. Thus, Hunt’s big choice is economics or politics. It would be the making of this advisor.

chris.giles@ft.com


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