The October Budget will tell us a great deal about how Rachel Reeves will act as Chancellor during this Labour government. As a result, before the Budget I intend to write a number of posts setting out the main macroeconomic issues as I see it. This first sets the scene, by questioning the idea that improvements in public services will come from better economic growth.
In her 2024 Mais lecture Chancellor Rachel Reeves said that
“it is through growth and only through growth that we can sustainably resource strong public services, raise living standards, and compete internationally.”
During the election, when Labour was pressed on how it would find money to improve public services while at the same time ruling out raising taxes on working people, the fall back position seemed to be that this would come from growth.
At first sight this idea is straightforward, and can be encapsulated in the following sentence. Higher real growth means rising real incomes, and higher income brings in higher taxes at existing tax rates, providing the finance for extra government spending, which allows the employment of more doctors, nurses, teachers and so on. However this simple intuition can be very misleading. To see why, consider the following very similar sentence. With higher inflation, higher nominal growth means rising nominal incomes, and higher income brings in higher taxes at existing tax rates, providing the finance for extra government spending, which allows the employment of more doctors, nurses, teachers and so on. The only change I have made to the original sentence is to replace the word ‘real’ with ‘nominal’, but the idea that inflation helps fund additional public sector jobs sounds wrong.
It is wrong, if by inflation we mean price and wage increases across the
