A look forward to the upcoming budget tells Kwasi Kwarteng that he must consider significant cuts to government spending or a massive tax increase if borrowing is to be kept under control.
According to a new official analysis, the government’s mini-budget has created such a massive hole in the public finances that the most credible option to repair it is with harsh spending cuts equal to those imposed during the austerity years a decade ago.
The “Green Budget” from the Institute for Fiscal Studies (IFS) and Citi warns that the chancellor would need to cut expenditure or boost taxes by £62bn to stabilize or reduce the national debt, as he has repeatedly pledged in recent weeks.
This deficit is a direct result of measures made since the Truss administration took office, including the reversal of several tax hikes, such as those on corporate tax and national insurance, and the Energy Price Guarantee.
There is a possibility that the vacuum will be filled by economic growth, but according to the IFS, such a result would depend more on chance than on good judgment.
It was stated that the Office for Budget Responsibility (OBR), the government’s forecaster, was not expected to presume at the end of the month that the actions in Kwasi Kwarteng’s mini-budget would improve the country’s long-term growth prospects.
Even increasing working-age benefits by earnings rather than inflation – one of the large and controversial money-saving initiatives being considered by the IFS – would only save a fraction of the necessary funds – around £13 billion per year, according to the IFS.
It was noted that Mr. Kwarteng will need to make more drastic cuts, potentially decreasing government investment and slashing public spending on ministries that have already been severely impacted by austerity.
According to the IFS Green Budget, the amount the government would spend on debt interest is projected to reach its highest level as a proportion of national revenue since at least the late 1940s.
This increase in debt interest is one component of a “premium” the government must currently pay due to investor concerns that it has lost part of its credibility.
Given the rise in borrowing accounted for by the mini-budget, this “credibility premium” results in a higher cost of borrowing in the United Kingdom than would have been predicted.
Moreover, Citi predicted that the increased mortgage interest rates experienced by customers in the coming years will also impair economic growth.
The IFS estimated the “credibility premium” for public finances to be approximately £10 billion, while Citi estimated the premium for economic growth to be between 0.1 and 0.2 percentage points.
Paul Johnson, the director of IFS, stated that, due to global instability, the forecast for the upcoming year was fraught with uncertainty, whilst Mr. Kwarteng faced significant fiscal constraints.
“Financial markets are scrutinizing the intricacies of the British government’s fiscal approach more closely than at any moment in recent history. The chancellor must not rely on overly optimistic economic projections or vague promises of budget cutbacks. This would jeopardize the legitimacy of his intentions, which recent events have demonstrated to be crucial.
“Despite this, we would sympathize with the chancellor if he concluded that the current level of uncertainty prevents him from pledging specific future actions regarding public spending.
“However, the same would apply to his recent tax cut deal. This reasoning should not be applied asymmetrically.”
Benjamin Nabarro, Citigroup’s senior UK economist, added: “Now that monetary and fiscal policy are moving in opposite directions, we believe the risks to the monetary-financial stability of the United Kingdom are mounting.
“In the next years,’ supply shocks’ like those saw in recent months are anticipated to occur more frequently. If we are to prevent another decade of stagnation, this may necessitate substantial changes in how macroeconomic policy is done.
“The United Kingdom cannot afford further policy errors,” he concluded.
