Digital Zeitgeist – Fiscal Tightrope: Curbing Inflation by Balancing Tax Hikes and Spending Cuts – A Daunting Challenge or an Economic Imperative?
In the face of surging inflation rates, the Bank of International Settlements (BIS) has recently urged governments to intensify their commitment to fiscal consolidation, arguing that they should either raise taxes or cut public spending. This advice, it argues, is critical for economies such as the UK, who need policies to temper price growth.
“The closing of the gap between government income and expenditure would ‘calm inflation’,” says the annual report from the Basel-based BIS, which counsels 63 central banks that make up 95% of the global economic output. By implementing spending cuts or tax hikes, governments could diminish business and consumer demand, constituting a decisive part of the ‘last leg’ in the battle against inflation. Despite a series of rigorous interest rate hikes by central banks worldwide, the struggle to rein in inflation is far from over.
Moreover , in its press release accompanying the annual report, the BIS cautioned that this final push would likely be the most arduous part of the fight to temper the rapid rate of price growth. Even as concerns mount over a potential recession for the UK economy after consecutive hefty interest rate increases, the BIS maintains that higher taxes and lower spending could “contain financial instability risks in several ways”.
This would not only diminish the need for further tightening of monetary policy but would also alleviate the risk of the sovereign becoming a source of financial instability. More importantly, it could provide additional leeway should public resources be needed for crisis management in collaboration with central banks. This assertive stance of the BIS invites governments to reconsider their fiscal policies seriously in light of a delicate global economic situation.
However, such policy advice doesn’t come without challenges, particularly in the case of the UK. The March budget by Chancellor Jeremy Hunt already loosened government purse strings slightly, despite freezing personal income tax thresholds which will increase the number of higher-rate taxpayers over the next five years. There’s understandable resistance from Conservative MPs to further tax increases when working households are already burdened with higher mortgage bills and rising shop prices.
On the other hand, The Taxpayers’ Alliance advocates for further spending cuts, yet they contradict the BIS by asserting that the funds generated should be used for tax reductions. This dichotomy in opinions illustrates the complexity of the task at hand for governments who need to appease their citizens while striving to achieve fiscal equilibrium.
In the scenario that efforts to significantly reduce inflation rates fall short in the short term, the impact on economies could be catastrophic. “The longer inflation is allowed to persist, the greater the likelihood that it becomes entrenched and the bigger the costs of quenching it,” warns the BIS. This statement underlines the urgent need to manage inflation, despite recent criticism faced by the UK government and the Bank of England for their alleged ineffective measures to tame it.
The notion that macroeconomic policy, such as decisions made by the central government or central banks, can determine long-term economic growth has come under scrutiny. Claudio Borio, head of the monetary and economic department at the BIS, suggests that overcoming this ‘growth illusion’ fallacy requires a shift in mindsets and acceptance of the limitations of stabilisation policies.
The BIS report emphasises that the role of fiscal policy will be crucial in this struggle. “To do its part, fiscal policy needs to consolidate. Consolidation would help tackle both the near-term and the longer-term challenges. In the near term, consolidation would calm inflation by reducing pressure on productive capacity,” the report stated.
However, in implementing these fiscal measures, a critical balance must be achieved between tax and spending policies, and interest rates to retain public faith in economic management. “The privileged powers of fiscal and monetary policy ultimately depend on an implicit social contract underpinned by trust in the state. People consent to paying taxes because they trust the government to use the proceeds for the public good. Similarly, people accept the use of money as a means of payment because they trust the central bank to preserve its value,” the bank articulated.
While the BIS’s clarion call for fiscal consolidation underscores governments’ critical role in battling inflation, it also elucidates the formidable task at hand. Amid increased living costs and the potential of a looming recession, governments are required to perform a high-wire act of curbing inflation without exacerbating the economic burdens on households.
In the UK’s context, for instance, where many are already grappling with higher mortgage payments and soaring prices, tax hikes or spending cuts could be perceived as punitive. The very real risk is that such measures could spark public dissent, potentially disrupting social cohesion and trust in the government. This delicate dance between fiscal prudence and societal stability illuminates the complex challenges that governments face in managing their economies effectively.
In contrast, the BIS’s advice does bring to the fore an often-overlooked aspect of economic management: that short-term pain might be necessary for long-term gain. As economies navigate their recovery from the COVID-19 pandemic, these policy directions might be seen as a bitter pill that needs to be swallowed to ensure economic stability in the long run. It serves as a reminder that while fiscal and monetary policies can stimulate growth, they are not panaceas for deeper, structural economic issues.
As an alternative viewpoint, one could argue that rather than slashing public spending or raising taxes – actions that could stifle economic growth or place more burdens on the public – governments could focus on promoting productivity and sustainable economic growth. By investing in education, infrastructure, and innovation, governments can help foster an environment conducive to business expansion and job creation, which can, in turn, generate more tax revenue in the long term and potentially offset inflationary pressures.
In conclusion, the BIS’s warning underscores the urgency for proactive economic management in these tumultuous times. While it may be tempting for governments to avoid making unpopular decisions that might upset their citizens, it’s crucial to remember that there’s no easy way out of complex economic problems. Clearly, striking a balance between fiscal consolidation and societal stability is not just an economic challenge, but also a test of political wisdom and public trust. As such, governments would do well to remember that their choices in the coming months could have far-reaching implications, not just for their economies, but for their social fabric as well.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of GPM-Invest or any other organisations mentioned. The information provided is based on contemporary sourced digital content and does not constitute financial or investment advice. Readers are encouraged to conduct further research and analysis before making any investment decisions.