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Last week‘s Briefing made the argument that recessions and external shocks change the structure of the economy. Such events also shift the political consensus. The second world war paved the way for a larger, more interventionist state. That model came unstuck amid the stagflation of the 1970s, ushering in Mrs Thatcher’s first government and the creation of a new liberal economic consensus around low inflation, free markets and limited government.

The pandemic has required a different approach, more akin to war time – almost unlimited government activism and radical innovation in economic policy. The demands of the pandemic have upended the normal rules.

Outside wars, never has an economic shock generated such a powerful response. Governments have eased fiscal policy far more aggressively than in response to the global financial crisis. Government deficits in advanced economies ballooned to 13.3% of GDP last year, twice the levels seen in the financial crisis in 2009. Governments have ransacked the policy toolbox, creating or expanding furlough and unemployment insurance schemes, providing grants and guarantees to corporates, issuing debt moratoria and deferring tax obligations.

The apparent insouciance of governments in the face of record deficits reflects a change in economic thinking caused by the financial crisis. Then, once the immediate damage had been contained, the focus switched to cutting government borrowing. The IMF warned that high public debt would weigh on growth while the governor of the Bank of England, Mervyn King, cautioned that the UK’s high debt levels could become difficult to finance. With the euro crisis, in 2010, the spectre of indebted countries facing soaring borrowing costs became a reality. The question of which country would become ‘the next Greece’ was on every bond trader’s lips.

The environment, and the policy consensus, today are utterly different. Instead of urging governments in richer countries to shrink public debt, the IMF recommends that they lock in record-low interest rates and borrow, and spend, in support of the recovery. Fed chair Jerome Powell and European Central Bank governor Christine Lagarde have warned governments not to prematurely tighten fiscal policy and cause avoidable economic scarring.

John Maynard Keynes is supposed to have said, “When the facts change, I change my mind”. Well, for now, the fiscal facts have changed.

When I worked in the City in the early 2000s the talk was of bond markets ‘policing’ the borrowing and spending of governments. Excessive debt levels would, it was said, trigger a sell-off in the offending country’s bonds, pushing up financing costs and bringing the government ‘back into line’. The low interest rates or yields on government bonds in the financial crisis were seen as temporary and, as a number of Mediterranean countries saw in 2010, could rise quickly. Once growth got going, and the slack in the economy created by the downturn was absorbed, inflation would rise and so would bond yields, making high levels of government debt unsustainable.

That was the story of much of the post-war period. But it didn’t play out that way after the financial crisis. Growth did come back, but it was weaker than before. Inflation remained tame and, aside from a brief spike in prices in 2011, central banks struggled to hit their inflation targets. Vast central bank purchases of government bonds in 2009–10 had created new demand for government bonds that had not been reversed. All of a sudden, central banks were major holders of government debt. By the end of the last decade, government bond yields (including yields on Greek government debt) were at historic lows.

With the legacy of the financial crisis in mind, institutions like the IMF and government policymakers see today’s record-low yields as a justification for government borrowing to offset the shortfall in economic activity. Fed chair Jerome Powell summed up the new consensus recently: “I'm much more worried about falling short of a complete recovery and losing people’s careers and lives that they built and the damage that will do to the productive capacity of the economy than about the possibility which exists of higher inflation.”

Beyond the views of central banks and economic institutions, media and public opinion also seems to have changed. In 2010, The Economist wrote that “the public sector must be put on a prolonged harsh diet”, with surveys showing a majority of the UK public viewing welfare benefits as too generous.

Public sector austerity and a greater focus on inequality seem to have shifted public opinion. The proportion of Britons who favour increasing taxes and spending more on health, education and social benefits rose from 31% in 2010, the year of David Cameron’s first election victory, to 53% in 2019.

On the eve of the pandemic, and more than ten years after the financial crisis, the UK public finances remained in deficit. In other words, a decade of austerity had merely slowed the rate at which the stock of government debt was rising. But instead of doubling down to bring the finances back into balance, the UK government declared the “end of austerity” in its pre-pandemic budget, including a focus on “levelling up” the UK’s regional inequalities.

Since then the UK has pursued one of the most aggressive programmes of fiscal easing anywhere in the industrial world. Yet few voices in politics or the media suggest this has gone too far. On the contrary, the tendency has been to argue for even higher public spending. For many the crisis has highlighted the power of government and the gaps in the welfare safety net and, in doing so, has made the case for even a permanently larger state.

The Overton window, named after US academic Joseph P Overton, describes the range of policies acceptable to the mainstream population. The pandemic seems to have shifted the Overton window and the agenda of mainstream political parties in the direction of a larger state.

This is not solely a UK phenomenon. In the US the Biden administration’s push for a $15 minimum wage, 100% carbon-free electricity by 2035 and student debt forgiveness is noticeably more ambitious than the Obama administration. Despite America’s polarised politics, there is broad support for increased government spending. Polls show seven in ten Americans support Mr Biden’s $1.9tn stimulus plan. Last week Republican senator and former presidential candidate, Mitt Romney, proposed the creation of a permanent child benefit, a remarkable proposal from a conservative US politician.

More than 30 years ago the then UK chancellor, Nigel Lawson, gave a lecture titled “The New Britain: The Tide of Ideas from Atlee to Thatcher”. In it, Lord Lawson reflected on changing consensus in economic policy in the post-war period. The political consensus he described then was of balanced budgets and small government, the polar opposite of today’s world.

It would be naive to believe that all constraints on fiscal policy have been eased or, in the parlance beloved of politicians, we have discovered a magic money tree. The current attitude to debt is a product of today’s exigencies and environment, just as attitudes of the 1980s reflected contemporary conditions. If conditions changed, and inflation and growth were to surprise on the upside the cheap borrowing costs that underpin today’s more tolerant approach to public borrowing, might disappear. As Greece found in 2010, bond markets can change their minds quickly.

For now economic policy is very much focussed on the risks of not doing enough to support growth. There is, as yet, no strong pressure or constituency for austerity. But as the economy recovers the assumption of low interest rates forever could face challenges. The balance between nominal growth on the one hand and market interest rates on the other will be one of the most consequential economic relationships of the post-pandemic world.

PS: Last week the UK Road Haulage Association said that information from road hauliers suggested that “loads to the EU have reduced by as much as 68%” compared to a year earlier since Brexit. UK-EU trade has certainly been severely disrupted, but as the veteran City economist, Julian Jessop observed last night, the 68% figure almost certainly exaggerates the toll: the effects of COVID on activity in Europe and the UK will have played a role in depressing trade compared to a year ago; many companies stockpiled goods in the latter part of the year to avoid Brexit disruptions in January, adding an additional, though temporary, depressant and shipping data, which showed a collapse in visits in late December and early January, have subsequently recovered.

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