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Imagine borrowing £800,000 every minute of the day…
Well, that’s approximately what the UK government racked up in the first five months of this financial year. Over in the US, the government is forecast to run a deficit roughly equal to the entire economic output of the UK (in a normal year). Dealing with a pandemic is an expensive business. Economists refreshing their forecasts for government debt to GDP are drawing lots of sharply upward-sloping lines.
But despite the recovery remaining firmly in its infancy, some are asking questions over what lies on the other side – to what extent do taxes need to rise, and on whom? Where should the burden of budget cuts fall? Familiar questions for those with memories of the financial crisis. Those alarmed over, at that time, multi-decade high deficits won out. Efforts to reduce deficits were enacted.
Even prior to Covid-19, attitudes to government deficits were shifting. The UK was in the process of pivoting away from austerity, fulfilling the promises made during last year’s election to rebalance economic success. The US had initiated a series of tax cuts, running fiscal deficits to the tune of around 5% of GDP. Germany was the holdout. But it was clear that something needed to change. Its export machine had been repeatedly buffeted by a series of events and a shifting global landscape: China slowdown, Brexit, trade wars, etc.
In other words, governments were tentatively beginning to act on the lessons of the past 10 years – currency-issuing countries with their own central bank can run sustained deficits without any hint of a sovereign crisis.
Mitigating the pain
The Covid-19 crisis has markedly accelerated that shift. Governments have just demonstrated that the power of the state can be harnessed to forcefully intervene to mitigate economic pain – whether through European governments replacing earned income or US-style cash disbursements and sizeable increases in unemployment benefits.
They, of course, are not acting alone. The crutch has been an activist central bank, paving the way with low, zero or indeed negative rates and large levels of government debt purchases to pin interest rates and keep debt loads manageable. That has left governments free to spend generously.
Even prior to Covid-19, attitudes to government deficits were shifting. The UK was in the process of pivoting away from austerity
Which brings us back to what lies beyond outsized government spending. What government now is going to revert to austerity in any meaningful sense? Can years of sustained below inflation rises in public sector wages ever be countenanced? Will society tolerate a large proportion of people living on modest unemployment income support?
Moreover, plenty of work remains to engineer a sustained recovery. What other cajoling might the consumer need in the shape of tax cuts or cash handouts? What additional support might the sectors at the sharp end of the economic fallout (consumer-facing services, aviation, etc) need?
That’s a lot of questions, and many people believe the answers lie in modern monetary theory (MTT). A dry-sounding topic, to be sure, but a New York Times bestseller on the subject – even tweeted by hip-hop star and actor Ice Cube – argues, among other aspects, that the financial constraints on governments (or currency issuing governments) are far less than widely believed. Government can run sustained, large deficits, free to focus on the economic and social impacts of policy and relieved of budgetary considerations (aside from inflation risk).
The interplay with other structural trends is obvious. The transition to a low-carbon economy likely requires considerable capital outlay, while there is a growing clamour for governments to mitigate income and wealth inequalities, of which technological change and globalisation are key drivers.
Investors might want to explore the implications of the MMT experiment going well or going wrong, when thinking about the balance of risks in the future. It just might be the key megatrend of the post-pandemic world in the decade to come.