Central Banks and Government Budgets - As If Democracy Matters

In Britain Tax austerity threatens to follow monetary and fiscal austerity

With acknowledgement to Bonil

Britain’s Chancellor, Rachel Reeves MP, is hell bent on further shrinking the nation’s income when she launches her 2025 Budget on 26th November.

She showed her determination to cut the nation’s ability to invest and spend in the 2024 Budget. Amongst other changes, she increased taxes, including employers’ national insurance contributions. As a result, and according to the conservative Institute for Fiscal Studies (IFS) UK unemployment rate rose to 5 per cent and wage growth slowed.

UK Unemployment is the highest for a decade, outside the pandemic period, and above the 4.9 per cent expected by economists. Payroll employment has fallen by 180,000. That loss of jobs for 180,000 British citizens results in further income losses, further contraction of spending and even fewer tax revenues for the government.

Predictably,

real disposable incomes fell by 0.7% in the first quarter of 2025.

And households, instead of spending into the economy are saving - i.e. hoarding.

By increasing taxes the UK Treasury cut the nation’s income by £32.1 billion more between April and September 2025 than it had done over the same period last year. That is £32 billion of investment and spending taken out of the economy over six months. Probably twice that over a year. £64 billion that will not be invested or spent by the economically active in new or existing economic activity.

The consequence for the government budget of cutting the nation’s income was predictable: As a percentage of economic output, the budget deficit rose - as night follows day. In 2024/25 it was 5.3%, up from 4.8% in 2023/24.

It may seem contradictory, but by increasing its own revenue while cutting the nation’s income the government failed to ‘balance the nation’s books’. Over the year and contrary to the expectations of accountants - the public finances were not improved by tax increases: they worsened. And they are set to worsen again if rumours about tax increases in next week’s Budget prove to be real.

The Office for Budget Responsibility assumes the worst, and predicts a deterioration of the current budget in 2029-30.

The macroeconomic consequence of cutting the nation’s income is a Budget deficit that will widen further, while an already weakened economy stirs political unrest. An economy that has still not fully recovered from the Great Financial Crisis and the COVID19 pandemic. Entrepreneurs dare not risk investment and instead increase unemployment; and consumers dare not risk investing and spending and instead are saving.

None of this is rocket science. It is macroeconomics.

That is not how the Chancellor sees it, as far as I can tell. There is a reason detractors refer to her, perhaps unfairly, as “Rachel from Accounts”. For this finance minister and Her Majesty’s Treasury (and for many of her advisers) the government budget is not about the government’s macroeconomic impact on the economy.

It is about accountancy.

Accountancy is not economics. But it is the basis for the assertion - and for many a kind of religious belief - that government is like a household or local authority and like a household has to balance its budget. It is accountancy that leads politicians to bewail the existence of “black holes” in the budget. And, even though the government owns the state’s most powerful institution - the Bank of England and its money creation powers - politicians and journalists yell hysterically into the void: “there is no money”.

Like households, the government is deemed to be short of cash and to have overspent. Unlike households or even the most powerful financial institutions, the government is in possession of some of the most valuable collateral in the world. The bond markets live in fear of the Bank’s power - real life bond traders have told me so. And yet the accountants (and technocrats) treat the Bank as impotent and unable to provide finance for a democratically elected government confronting private economic failure and political instability.

That’s like saying that despite his ownership of the huge and profitable corporation that is Tesla, Elon Musk cannot afford to leverage finance against his ownership of some pretty significant collateral - his shares in Tesla.

Repeat after me: government budgets are not like household budgets. They do not have to balance. The state - and in particular the British state - has enormous (collateral) power to mobilise the finance needed to meet the economy’s needs, as we learnt during the GFC and the pandemic.

Given the threat of authoritarianism and the rise of fascist and racist narratives, the British state and its elected politicians must use their great power to tackle the new affordability crisis and create skilled, well-paid jobs as a way of raising incomes, ending inequality and restoring prosperity. Timid and fearful, and frankly spineless capitalists are unlikely to have the vision, the guts or the courage to help society overcome fascist tendencies and achieve that goal.

Once employment rises, needs are satisfied and the economy booms, the British state and its central bank can use their awesome power to deflate the boom, curtail inflation and prevent Budget imbalances - both surpluses and deficits.

That is why austerity is for booms, not busts.

Once again say after me, and as Keynes once argued: the British Chancellor, Rachel Reeves, cannot balance the nation’s budget by cutting the nation’s income.

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The Democratic Deficit

Ms Reeves’s 2024 Budget and her threat to increase income taxes in the forthcoming 2025 Budget has led to a significant collapse in support for the British government. British voters elected this government to end austerity and insecurity; to support and expand economic activity, to end wealth inequality and to ensure the well-being of the most vulnerable (i.e. children, the elderly and the sick). Nobody expects overnight change - clear political intention, vision and effort is what matters.

Voters prefer governments that raise tax revenue - not by taxing the already struggling - but by creating conditions for sufficient skilled and well-paid employment, household and corporate income - with which to generate the tax revenues needed to ‘balance the books’.

In short, British voters want the government to use its great powers - to intervene in the economy -

as if democracy matters.

Voters in a democracy do not support a state that is fearful of its own power and that inflicts austerity on innocent civilians.

That much is basic politics.

Monetary Policy as if Democracy Matters

The phrase “as if democracy matters” - is not my own. It is drawn from a timely book that has taught me a great deal which I hope to share with subscribers. It is by Leah Downey and its full title is: Our Money: Monetary Policy as if Democracy Matters.

Her book is authoritative, well reasoned and a balanced examination of the democratic deficit inherent in central bank policy-making. She is also not daunted by some of the more arcane aspects of economic and central bank policymaking. Instead in chapters that require some understanding of monetary theory, she digs deep into, for example, central bank policy of paying interest to commercial banks on excess reserves (IOER) held at the Fed or Bank of England.

This is technical stuff but Downey moves on from technocratic issues to the central question of power. Monetary policy as conducted by central bankers, she argues, is political: it is about power.

The power to decide on what basis to create a nation’s money: how much money should be created in the aggregate; how that money should be distributed between private and public sectors; and at what ‘price’ (the rate of interest) money should be made available to governments and the private sector.

Monetary policy is a foundational power of the state, and yet in most modern democracies it is wielded by independent, unelected experts and implemented through private financial markets. Decisions about if, when, and on what basis to create money are insulated from democratic politics. (Emphasis added)

In other words today ‘good’ monetary policymaking requires the presence of expertise and the absence of democratic power - or politics. Under the current system (it was not always thus) central bankers set aggregate boundaries and limits for the creation of money, by both the state and commercial banks - and only then do

fiscal authorities make distributional decisions.

Unfortunately citizens of the world’s democracies have been persuaded that these great powers exercised by publicly backed central bankers requires the “absence of politics”. That democratically elected parliaments and governments should not intervene in the setting of monetary policy. We have come, she writes, to

the convenient yet dubious conclusion that the legislature has no good reason to actively manage monetary policy.

The ‘we’ used here is doing some heavy lifting. Those dubious conclusions are largely pushed by the mainstream economics profession and their friends in the media and private financial markets. - not to mention central bank technocrats.

Yet Downey does not join in the chorus of criticism poured on central bankers. Instead she writes, reasonably that parliaments disempower themselves - deliberately.

The dominance of central banks is not a claim about the intentions or motivations of central bankers. Central banks are not full of power-hungry agents working to steal control from the legislature. While central banks have an incentive to protect and sometimes expand their powers, the legislature also has an incentive to shirk responsibility for monetary policy.

..the dominance of central banks is driven in no small part of by legislatures frightened of the responsibility that comes with exercising political power.

The British Parliament - whose elected politicians are in awe of both technocrats and monetary policy - has delegated great power to unelected technocrats at the BoE . Just as the Treasury has delegated power over fiscal policy to the OBR, and worse, used ‘fiscal rules’ to limit its own power to spend on both physical and social infrastructure.

If Britain is to raise the finance needed for economic recovery; and for a great transformation of the economy away from dependence on fossil fuels, parliament needs to grow a spine..and to take responsibility for monetary and fiscal policy.

Parliamentarians need to reclaim power over monetary policy - and to do so as if democracy matters.