The chancellor has changed direction but policy uncertainty comes with costs 

Two months since he presented his spring statement to the Commons, and after months of weeks of pressure and government resistance, Rishi Sunak’s speech to the House of Commons marked a change of approach from the chancellor. It also demonstrated a clear diagnosis of the economic problem facing the UK. 

As we set out in a recent paper, the UK’s current economic weakness stems from problems on the supply side leading to rising inflation. This means the chancellor cannot offset the pain for all households. To bring domestically generated inflation under control, the Bank of England needs to raise interest rates to dampen economic activity and bring demand back in line with supply. This means any attempt by the chancellor to boost incomes across the board will simply be offset (on average). However, there is an important role for fiscal policy in deciding how the pain of the economic slowdown will be shared. 

Most of the new support announced by Sunak was targeted on the most vulnerable households – those with low incomes or particularly high energy costs. There was additional broad-based support, from converting the previously announced energy bill rebate into a non-repayable grant and doubling its size. But he resisted pressure from some of those on his backbenches to announce broad based tax cuts, such as to VAT or income tax. 

He also emphasised what the government was doing to expand the supply side of the economy – including measures on immigration and supporting older people back into work – as we suggested in our report, though there were no new measures to address (for example) the sharp rise in economic inactivity due to long-term sickness among older people or the shortage of low-skilled labour. 

Focusing support on low-income households suggests a shift in priorities 

The measures announced by the chancellor earlier in the year to address the cost of living crisis were predominantly broad-based, with only a small amount of help targeted on the lowest income and most vulnerable households through a discretionary fund managed by local authorities. The exact opposite is true in the chancellor’s new package: most of the new support (three quarters according to the chancellor) is focused on low income and otherwise vulnerable households – an approach which commentators and campaigners have been urging the chancellor on for months (although there are still some gaps, such as relatively less generous support for large families).^[1] 

Little has changed since March in what we know about how the pain of the economic problems is being felt. So the shift in the balance of policies looks like a change of priorities within government. 

One area of consistency between March and now is the lack of support for businesses. They have also faced sharply higher energy costs and are not protected by the price cap, meaning energy costs are now one of the most cited concerns for private firms. There can be good reasons for the government not stepping to help all businesses, but ministers will need to keep an eye on how businesses are faring, particularly as competing firms in other European countries are being supported by their governments. 

A sizeable fiscal stimulus makes the Bank of England’s job harder 

The chancellor announced an extra £15bn (0.7% of GDP) of giveaways to households, which will provide a sizeable stimulus to the economy. The fiscal impact will be partly offset by a £5bn levy on oil and gas companies. But the net effect on demand in the economy will probably be larger than this net fiscal cost suggests. The giveaways are likely to be spent, since they will mainly go to households who are struggling to meet their living costs. But the levy will probably not feed through into much immediate reduction in spending. This is because some oil producers have already indicated the tax would not affect their investment decisions and dividend payments (which could be reduced by the tax) tend to go to people with a high propensity to save, rather than spend. 

With signs that the UK economy is already bumping up against – if not already above – its supply capacity, this stimulus to demand risks pushing inflation higher. It is therefore likely to prompt the Bank of England to raise interest rates even higher than they otherwise would. This is the bank’s job, it has the tools needed to keep inflation under control, and it is better placed than government to pursue this end. The government should not, therefore, be overly concerned but its actions do increase the size of the problem facing the bank.  

The chancellor is in a sensible place but uncertainty over policy direction has real costs 

Barely two months have passed since the chancellor’s spring statement and already he has returned with a further large package of measures – one which looks very different in substance to the plans as of March, including adopting the previously rejected ideas of a levy on oil and gas companies and more targeted help for vulnerable households.  

Sunak is right to say that the outlook is uncertain and so there needs to be scope to adjust policy, but what we have learnt in the past two months is not enough to explain the substantial realignment of policy. It is barely over a week, for example, since Tory MPs were told to vote against a windfall tax on energy companies. 

There continues to be uncertainty about what the government plans to do about “extraordinary profits” earned by electricity generating companies, with the Treasury so far simply saying the  government will “urgently evaluate…the appropriate steps to take”. Ongoing speculation about policy and uncertainty about what the government is trying to achieve has real economic costs. The UK economy is already facing enough problems without adding this self-inflicted harm. 

1. Resolution Foundation, Pressure points: Where, and how, to focus Government support for households facing surging energy bills, 25 May 2022, www.resolutionfoundation.org/publications/pressure-points