Chancellor Rishi Sunak has a whopping cash flow problem. Locking down the economy in response to the Covid-19 pandemic means that tax revenues have dried up at a time when the state is promising to spend billions more on health, wage subsidies, small business grants and universal credit. It’s not unusual for the state’s spending to exceed its revenue and when it does the gap is normally covered by borrowing. The government sells bonds – or gilts – to investors and uses the proceeds to plug the hole.
In the current crisis, the government’s need for ready cash is so great it can’t get the gilts out of the door quickly enough. Fortunately, though, Sunak has an understanding bank manager in the form of Andrew Bailey. The governor of the Bank of England, has agreed to solve the Treasury’s cash flow problem by printing as much money as the chancellor needs provided Sunak agrees to pay off his overdraft by the end of the year.
This may sounds a bit technical, but it matters a lot. For the time the economy is effectively being kept going by the state. Only bits of the private sector are operating as normal and the longer the lockdown the bigger the bill for the Treasury. All of which raises the question of how it is to be paid for. More specifically, does the use of the government’s overdraft facility mean that the UK is heading down a road that ends with the Bank printing money to pay for government spending?
How the government goes about footing the bill for Covid-19 depends on the scale of the economic damage, but it is already clear that early estimates of a short, sharp shock were too optimistic. The current crisis looks likely to prove more costly than the recession of 2008-09, until now the deepest slump of the post-war era.
Sunak has options. Do what George Osborne did in 2010 and impose a period of belt-tightening as soon as the recession ends. This would involve an austerity budget – or more likely a series of austerity budgets – in which taxes would be raised and spending cut in order to reduce the size of the government’s annual budget deficits.
This option is unlikely to prove all that attractive. The lesson of the Osborne experiment is that trying to get the deficit down too fast leads to sluggish growth, which reduces tax revenues and means it takes longer to reduce borrowing. Moreover, the tightest financial settlements on the NHS in its history left the health service poorly prepared to cope with a pandemic. There will be political uproar if Sunak goes to the austerity route.
