Over the past six months, governments across Europe have reacted in different ways to the energy price crisis. Because the crisis has arisen so quickly, due to the war in Ukraine, governments have not had the luxury of time to come up with thoughtful measures to protect households and their wider economies. The result has been quite chaotic. The initial measures have been ad hoc, and direct rather than targeted, in support of all consumers. The cost of these efforts has amounted to more than 1 percent of the EU’s GDP, according to the Brussels Bruegel Institute.
With more time for reflection, governments can now introduce additional, more focused measures to help those worst affected.
Until the end of August, the UK’s support measures had been on the same scale as in the EU. While all governments, including ours, want to do more for households and businesses this autumn, the announcement by the new UK government last week of a further subsidy package of up to 5 per cent of GDP is likely to dwarf policy intervention in the EU. If the proposed interventions were better targeted at those most in need, they would be more effective and cost much less.
On top of this spending, the British government under newly elected Prime Minister Liz Truss also plans to cut corporate tax and reverse the rise in social security contributions, costing another 2 percent plus of GDP – a total of 7 percent of GDP to be financed by borrowing.
The huge sums which the British government plans to borrow must come from abroad rather than from domestic savings
There has been very limited consideration in the UK of the macro-economic significance of these interventions. Although the new borrowing will still be lower than that done during the pandemic, from a macroeconomic point of view it is very different in nature. During Covid, the extra spending in individual countries was funded from the increase in household savings because people couldn’t spend in lockdown. In other words, governments, in Britain and elsewhere, borrowed from their own citizens rather than from abroad.
This time, with households under pressure from rising prices, savings will fall below normal. Corporate loans will rise to see them through this crisis. The huge sums which the British government plans to borrow must therefore come from abroad rather than from domestic savings.
Back in August, before these additional spending plans, Britain was facing a balance of payments deficit of 7 percent of GDP by 2022. Financing this meant Britain was already taking out large foreign loans, or weakening its assets. The plans now announced will dramatically increase the UK’s external financing needs this year and next.
Provided the rest of the world believes that the UK government’s policies are sustainable in the medium term, funding will be available overseas at a reasonable cost. It’s a big if. As we know all too well, interest rates can rise dramatically if financial markets lose faith in government policies. Sterling would come under pressure and exacerbate inflation. So this is a dangerous course. The risks are heightened by the decision to sack the respected head of the Treasury, Tom Scholar, a safe pair of hands.
The humiliation of the 1970s
Britain has been here before, and it didn’t end well. In the 1970s, the then Labor government also borrowed heavily to insulate the economy from the loss of income resulting from a rise in energy prices. But by 1976 the foreign lenders had dried up and, humiliatingly, Britain had to seek aid from the IMF. I remember that year when I attended an OECD meeting as a junior Treasury official, hearing Alan Greenspan (future head of the US Federal Reserve) and Hans Tietmeyer (future head of the Bundesbank) decry the UK government’s wasteful “socialist” policies , in unusually political commentary.
The gas price crisis is likely to continue into 2024. Our government needs to step up and keep a reserve for years to come
This time, the new Conservative government’s wasteful policies could create similar difficulties for the UK economy if its lenders lose faith. In principle, the Bank of England, if it remains independent, could try to stop a fall in the pound by raising interest rates. However, such a solution would mean a heavy blow to economic growth in the UK.
The vulnerability of the British economy is a serious concern for the Republic, not only because the British economy is important to us, but because of our close personal ties with so many British residents.
The gas price crisis is likely to continue into 2024. Our government needs to step up and keep a reserve for years to come. We need a smarter approach than the UK’s, with a targeted response policy to focus aid where it is most needed.
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