Updated: Jun 21, 2020
“There are decades where nothing happens, and there are weeks where decades happen.” — Vladimir Lenin
If you have been following the news recently in the UK, you’ll likely be aware that new measures have come into place to protect businesses who have had to close temporarily, and to workers who have been furloughed (on a temporary leave of absence). These measures have initially promised at least £330 billion worth of loan guarantees, and other financial aid to the necessary parties, by the Chancellor, Rishi Sunak. Mr Sunak even went as far as saying that, “If demand is greater than the initial £330bn I’m making available today, I will go further and provide as much capacity as required.” Some of these measures include grants to companies so that they can pay up to 80% of their employees’ wages (up to £2,500 per month), deferring VAT payments by up to three months, and cash grants of up to £25,000 per property for businesses in the retail, hospitality and leisure sectors.
For a more comprehensive list of some of the government measures to support businesses, please click the link here.
A frequent question that I have received over the last days is how the government will fund this aid package. Consequently, within this article, I will attempt to succinctly summarise how the government can afford its coronavirus response package, and why other methods may be less suitable or effective.
The UK government will borrow money to fund its response to COVID-19. With a national debt of almost £2 trillion GBP, to most, borrowing even more money (estimated to be at least £160 billion this year as a result of the pandemic), seems like the worst course of action. However, as you will read below, printing money, which the government is currently doing to a small extent, while necessary, isn’t a great alternative. Likewise, raising taxes to pay for the aid package would defeat the object of the support, by “sucking spending power out of the economy.“
So, the government will borrow money, by issuing debt to financial markets. Government bonds, or gilts, will be offered. Simply put, these are paper certificates which the government issues to investors, with a long-term maturity (expiry) date, and a yield that exceeds the UK interest rate, which is currently extremely low. As a result, investors will get a better rate of return than if they were to put their savings in a bank, and so gilts offer a more attractive option.
The issue with borrowing is that, as aforementioned, it is not mitigated by a tax increase. This means that the government is not funding its aid package by increasing various taxes, as this would be self-defeating. Therefore, the only way that the government can afford to borrow at the moment, is with a combination of issuing debt, and the generally-inflationary quantitative easing.
As the financial writer Lisa Smith states, “If there were awards for the most controversial investment terms, ‘quantitative easing’ (QE) would win top prize.” In simple terms, quantitative easing is a method that has historically been used by central banks to bring relief to economically critical situations. It is effectively done by ‘printing’ money – essentially creating it from nothing. While many may think that this is a wonderful solution – an increased money supply in the economy will encourage increased consumption – one only has to look at the crumbling of the Weimar Republic and the Wall Street Crash in the 1920s, or Zimbabwe in 2007, to see that printing more money can lead to the noxious effects of hyperinflation. Of course, this is not to say that quantitative easing always ends in disaster, but it is a possibility. If you want to learn more about how QE works, I recommend clicking on the link here.
In the current situation, wealth in the UK, and around the world, is being destroyed. There is significant deflationary pressure, and so, by implementing a policy of QE, it is assumed that inflation would increase, thus offsetting the deflationary pressure. In this way, wealth could be rebuilt, and purchasing power, which undermines wealth, would be partially restored.
The subsequent question is, who will bear the brunt of this borrowing and quantitative easing? The simple answer is us – all of us who live and work within the UK. With an extremely high debt bill, the government may have to reduce its future spending on sectors such as healthcare and education, which as consumers, we will inevitably suffer from. Furthermore, one can expect tax rates to rise in the future as well.
One may ask whether these aid packages are necessary, but Robert Chote, the Head of the Office for Budget Responsibility, summed up the situation in the following way:
“This is not a time to be squeamish about one-off additions to public sector debt. It’s more like a wartime situation.”
In conclusion, whilst costly to the UK as a whole, these measures are necessary. If they are undercooked and under-provided, we can expect to see mass unemployment, hundreds and thousands of businesses destroyed, and long-term damage to the economy.