Get used to this
George's Plan A is to pray for growth, and in both the 80s and 90s it was a resurgence of growth that came to the fiscal rescue. Unfortunately, with debt overhangs and busted banks all around us, we're now in a much more difficult position than we were back then. The growth rescue looks to be way off, and George knows it.
Which is why he's now busily working on Plan B. It's the traditional plan for over-borrowed governments everywhere, and its ingredients are as follows:
- Engineer higher inflation by printing money - in an open economy like the UK it's quite easy because currency depreciation soon gets prices moving up.
- Fail to index tax thresholds in line with higher prices - that boosts income tax revenues as earnings respond to higher prices (aka fiscal drag), adding to the higher revenues flowing from VAT.
- Limit spending in cash terms- hold spending departments to strict cash limits.
First, he confirmed in the Budget that under his new flexible friend Governor, the Bank of England will no longer be restricted to a 2% inflation target. In future, it will be allowed to set itself "intermediate thresholds", such as keeping "interest rates low while unemployment is high, provided inflation is not expected to rise too much". How much inflation is too much? That's for him and the Governor to choose, and you to fret about as you watch your savings disappear down the plughole.
Second, he's increasing the higher rate income tax threshold by only one percent a year, even though inflation is running much higher. The £150,000 threshold at which the top rate of income tax applies is frozen altogether, as is the £100,000 threshold above which the personal allowance starts being clawed back. The higher is inflation, the more harshly these measures will bite, with around half a million additional taxpayers being dragged into higher rate tax over the next two years. Similarly, the threshold for Inheritance Tax has been frozen at £325,000 since 2009.
Third, he announced in the Budget a huge increase in the scope of departmental cash limits. He said:
"The public spending framework introduced by the previous government divided government spending into two halves: fixed departmental budgets and what is called Annually Managed Expenditure. Except in practice it was annually unmanaged expenditure – and it includes almost the entire welfare budget as well as items like debt interest and payments to the EU.
We will now introduce a new limit on a significant proportion of Annually Managed Expenditure. It will be set out in a way that allows the automatic stabilisers to operate – but will bring real control to areas of public spending that had been out of control."Exactly how it's going to work is unknown, but the intention is clear enough. And it promises a revolution in the way that welfare spending is controlled. Because instead of pre-committing to pay whatever bill the agreed rates of welfare benefit generate, he's saying the total amount will be cash limited. Benefit rates and entitlement rules will have to be flexed to fit within a cash ceiling, and that will have to include upratings to cover inflation.
As for debt, higher inflation will obviously erode the real value of government obligations fixed in cash terms, notably its issues of so-called conventional gilts. True, its index-linked gilts will have to be adjusted in line with the higher inflation, but since they only comprise one-quarter of total gilt issues, the Chancellor comes out well ahead.
Of course, there is a serious risk that what he gains on the debt erosion swings he will lose on the debt interest roundabouts. If the markets lose confidence, as they did when a similar scam was tried back in the 1970s, interest rates on new gilt issues will shoot up and debt servicing costs will take off. Even so, because the existing stock of debt has such a long average maturity, it will take a couple of decades before the full impact is felt.
So that's Plan B. And it's worth noting what the world's most successful central bank ever has to say about it:
"Government debt fosters the risk of inflation. Central banks, too, are usually exposed to the strong pressure that burdens states with high levels of debt. This is because the higher the pressure on the government to get the public debt under control, the greater is the temptation to exert pressure on the central bank to lower interest rates via monetary policy measures...
If, in order to safeguard its solvency, the government pressures the central bank to set a lower interest rate than is compatible with price stability, demand increases too quickly, and this ultimately leads to higher inflation. In this case economists speak of a regime of fiscal dominance: interest rates are no longer set according to the requirements of price stability but instead are dictated by the state’s need to reduce its financing costs.
Measures taken by central banks in the past, under the influence or control of the state, to lower interest costs or to reduce the overall debt burden, have ranged from straightforward interest rate reductions to purchasing government bonds in secondary markets and to direct monetisation of government debt.
To be able to resist this political pressure, central banks have traditionally been granted a high degree of independence. This was, among other things, a response to the experiences of the 1970s and 1980s. This era of oil price shocks posed a major challenge to monetary policy-makers. It became apparent that countries with independent central banks had much lower inflation rates – and similar or even higher growth – than countries whose central bank was answerable to the government.
Central bank independence is therefore essential to inspire confidence that the central bank will keep inflation low. However, a high government debt burden can generate doubts about its actual independence and undermine its credibility, even if it has not actually changed its monetary policy course. Once doubts arise about of the monetary policymakers’ capability to defend their independence against political interference, they risk losing control of inflation expectations and thus over inflation itself."That's the Deutsche Bundesbank speaking - the rock-solid guardian of German economic stability right up to when the Germans were bounced into the Euro.
My advice? Get down to the building society, draw out all your cash, and get yourself some of these:
Yes, I know - easier said than done. Personally I'm going to contact the Major's old mucker Mr Gomulka who apparently has a lock-up full of them.