UK’s Macroeconomic Policies Could Add To Risk From Brexit

While Brexit has been the center of attention for the UK over the past year and a half since the vote, the economy also faces substantial risks from the UK’s own macroeconomic policies. A new paper from the Washington, DC-based Center for Economic and Policy Research (CEPR) concludes that it “makes economic sense” for the government to finance infrastructure, education, and other public investments to spur lagging productivity, while avoiding cuts to public pensions or attempts to make deficit or debt reduction a main goal in the foreseeable future.

“The UK has been stuck in a low-wage, low-growth, low-investment, no-productivity-growth trap for a decade,” said Mark Weisbrot, CEPR co-director and lead author of the paper, “The UK Economy at the Crossroads.” “There is a serious risk that the Bank of England and UK government will prolong this stagnation, or worse, with overly tight fiscal and monetary policies.

“Of course any damage from mistaken macroeconomic policy compounds the risks and potential damage surrounding Brexit,” he added.

The report argues that despite high levels of employment after eight and a half years of economic recovery, expected interest rate hikes by the Bank of England are unnecessary in view of the recent trajectory and sources of inflation, as well as wage growth. Real median wages are still below their 2009 peak.

On fiscal policy, the authors maintain that the focus on reducing UK public debt as a percent of GDP is misplaced; the more important indicator is the percent of GDP going to service the public debt, which is just 1.8 percent of GDP and unlikely to undergo sudden changes. They note that the UK can borrow at negative real interest rates on 10-year government bonds, and argue that it should do so in order to finance badly needed public investment. The paper also looks at the UK’s high levels of regional inequality ― the worst in the European Union ― and overall income inequality, and argues that public investment will have a role to play in solving these problems.

The paper comes at a time when there is much debate about tightening the budget. The authors note that about half of the deficit reduction since its peak in 2009 is attributable to fiscal tightening, and that this “was unnecessary as well as painful for many people. In addition to unnecessary unemployment and poverty, and the accompanying social ills caused by the slower recovery, the spending cuts were also linked to an estimated 120,000 deaths as a result of decreased access to health and social care” (according to a study in the British Medical Journal).

The authors also argue that proposed cuts to the public pension system would reduce one of the most important equalizing factors with regard to income distribution in the past decade, and note that these reforms would have an insignificant impact on the budget, with an average annual savings of just 0.06 percent of GDP over the next 50 years.