Is Rachel Reeves' black hole ‘made up’?

0:00Coming up, the black hole. None of us can see it, but the politicians keep talking about it. With the budget fast approaching, what exactly is the black hole in the nation's finances? And can the Chancellor do anything to plug it?

0:14Ed Conway:How does a banana trigger a CIA-backed coup? Do AirPods herald the arrival of a new global order? What do LED lights say about the future of humanity? I'm Ed Conway, and in each episode of my new podcast, Stuff Matters, I take an object, crack it open, and reveal the world-shaping forces hidden inside. This is economics told through the things we think we understand. Search Stuff Matters on your podcast app to listen and follow.

0:47The government's in a bit of a mess right now, so too the economy, and you might fairly surmise the two are linked. Certainly it's hard to think we'd be openly speculating on the health secretary trying to oust the Prime Minister if the British economy more closely resembled something with a heartbeat. Of course, Keir Starmer, Chancellor Rachel Reeves, even Wes Streeting would say that the economy's in the state it's in because of the other lot, the last Tory government. That's why there's been one term bandied around by Labour since day one in power. And when Rachel Reeves delivers her budget, you can bet the nation's GDP that should be mentioning it at least once.

1:24And the phrase is the black hole. It's usually identified as being around£22 billion in size and is regularly used as a means of bashing the previous government. Also, to explain why the Treasury can't allocate the funds to do all the things it promised it would in its manifesto. So, what actually is it? Is it real? Why is it an issue? And can Rachel Reeves do anything about it? Ed Conway is our economics editor. Look, this is a strange one for me because I think I know more about actual black holes than the one that Rachel Reeves keeps referring to. What does it mean when she uses the phrase?

2:02Ed Conway:Except that we have gone on about this quite a lot, like headroom and black holes, to the extent that every time we have a conversation about it, you see me slightly kind of seizing up with frustration. And the reason is that when people talk about this in Westminster, sinister it's about like there being some definitive notion of headroom she's got this much headroom or there's a black hole and she's facing it and blah blah blah if you read a lot of the coverage that's what you might think as well because it's cast as always capital b capital h but it's a made-up thing that's the key thing to note about this from the very start it is a self-imposed constraint the black hole is invented by the government so it comes back to the fact that this government, like previous governments before, has a set of fiscal rules.

2:47Ed Conway:And what those rules are, every government since Gordon Brown has said, OK, because we're aware that there's this history in the UK of markets getting a bit nervous about what we're going to do with our spending, we're going to set some rules which say this is the limit, OK? I'm not going to borrow beyond that limit. I'm not going to let debt go beyond that limit or I'm going to control it in some way. But the main rule that's kind of binding Rachel Reeves right now is that she needs to get the current budget, which is all that is is basically total spending minus investment and then you take away the taxes coming in.

3:17Ed Conway:So you've got taxes coming in, spending going out. She wants to get that up into a surplus rather than a deficit. In essence, she doesn't want to spend more money than she's got. Exactly. You put it much better than me. She basically wants to have more money coming in than going out. And right now, at the moment, the way the sums are, the way they were the last time they were put together by the Office of Budget Responsibility, which kind of does those sums, last time they looked at it, they said, OK, by the end of the parliament or so, you've got about£9.9 billion in surplus. In other words, that's your headroom.

3:45Ed Conway:You're£9.9 billion away from missing your rule that you set. And so when people talk about black holes, it is all in relation to that. Are you going to hit that rule or miss that rule in four or five years' time? So when Rachel Reeves and every other member of the Labour cabinet since the moment they enter Downing Street refers to a£22 billion black hole, what does that mean? What it means is we did have£9.9 billion to spare before we broke the rule. Other stuff has happened in the intervening period. There was the U-turn on welfare. There was all of these things, winter fuel payments, all of these things that they thought were going to save them money.

4:24Ed Conway:They haven't been achieved. And as a result of that, more money needs to be spent in the future. Total all of that stuff up and you're talking maybe about£10 billion. Then take an extra maybe£5 billion because they promised a few things. So toss it all up and already thanks to the U-turns and thanks to the things they've committed, you'll know already from your kind of mathematics,£10-15 billion, that's bigger than your£9.9 billion. So all of a sudden, all of that leeway against the rule that they set, by the way, all of that leeway has gone and you're breaking the rule. The reason people talk about a black hole is, in this case, all black hole means is what does it take to get you back to where you were, you know, whether it's£9.9 billion or something more.

5:03Ed Conway:What's the consequence, the practical consequence of this black hole? You could make the case there are certain problems with the public finances and problems with the economy that definitely are the legacy of either mistakes or just things that haven't been done for years and years and years. But what people are talking about now with a black hole is not that. This is not like the Tories have left this black hole. it is quite literally there is a gap between what Rachel Reeves has committed to doing and where she is heading right now. What we've learned in the last year or so is that this government doesn't seem to be very good at fulfilling some of the difficult decisions, spending cuts that it has promised.

5:38Ed Conway:That's self-evident. It said that it was going to raise about£5 billion with welfare reforms. It hasn't been able to do that. £5 billion is a lot of money. It's getting towards a one penny cut in national insurance. And so if you're not able to do that, then all of a sudden you have to find that money from somewhere. and that's why people are now talking about tax rises. The only other thing that's worth just adding, okay, so they started at£9.9 billion, so in the green. That instantly was kind of wiped out by a lot of the promises that they've made. And then on top of that, she has the added headache that the Office for Budget Responsibility, who are the ones who are kind of saying, well, here's where you're going to be in five years' time, are also at the same time thinking to themselves, well, the economy doesn't look like it's doing that well right now.

6:14Ed Conway:Are there some long-term, deep-seated issues that we have right now? Is our productivity not as strong as we thought it was? Because if that's the case, then you're not generating as much money across the economy. We're not all as well off and therefore we're not paying as much in taxes. And then all of a sudden your deficit gets bigger. And so on top of the self-inflicted bit of the black hole, the pointy heads are coming in and they're looking at the economy and they're saying it's a bit worse than expected. And so what looked like it was maybe kind of down from 9.9 to maybe minus 5 is now kind of more like minus 15 or maybe minus 20.

6:45Ed Conway:and things start at that point to look like, OK, small tax rises aren't enough for this. You need big stuff. Whose fault is it that we find ourselves in these circumstances? I mean, if you ask Rachel Reeves, she joins the dots all the way back to the mini-budget. Sorry, in inverted commas, the disastrous mini-budget from Kwasi Kwarteng and Liz Truss. So there's two things. So there's the downgrade of growth from the Office for Budget Responsibility, the expected downgrade of long-term growth. This economy is just not doing as well as had been hoped. And there might be a bit of it that's down to Brexit.

7:17Ed Conway:There might be a bit of it that's down to the fact that post-COVID, our labour market hasn't really come back to where it was before. There might be a bit of it that we've de-industrialised and we're just not doing as well as we have before. Ukraine as well, definitely. The fact that energy costs are much higher right now, things are more expensive to make. And then also just there's this bit of a mystery out there in the global economy. We just are not growing as fast as we used to. And that's a problem that we've seen since the financial crisis. She can understandably blame a lot of that on her predecessors.

7:43Ed Conway:That's part of it. But there's the deeper, if you're talking about why is she in this position right now, there is also the kind of straightforward fact that she set herself fiscal rules. She's set to miss those rules. She already kind of came close to missing them already. She's now going to kind of miss them again. And that is desperately awkward for her. Back to Liz Truss. You can connect the two. Why is it that she came into office saying, I'm going to have these fiscal rules? it's partly because of what happened in 2022 with the mini budget because that was the one occasion in recent history where a chancellor has said i don't really care about fiscal rules and then of course we all know what happened next and so you've had this knee-jerk reaction where both of the main parties and pretty much all of the parties are basically saying oh well obviously we will have fiscal rules and obviously we will listen to whatever the office of budget responsibility has to say to us i suspect that there'll be people listening to this like me who are still struggling with the concept of fiscal rules.

8:38Imagine a world without any fiscal rules. What is it that Rachel Reeves could do absent those rules that she can't do with them? We lived in a world without fiscal rules before 1997. You know, Gordon Brown was the first chancellor

8:52Ed Conway:to have fiscal rules. They didn't exist before. So I think the fundamentalist point is if you don't have fiscal rules, the market provides the discipline. And investors out there decide they're going to charge you much more to lend to you if they think you're a bit dodgy and they think they're not going to get their money back. That's how it's worked for decades and decades. But government after government has decided recently that they needed something extra to demonstrate how serious they were about keeping the public finances in order. You can actually go back through history and there was time and time and time again for decades if not kind of centuries where politicians have a tendency to want to spend more and then go into crisis.

9:32Ed Conway:So they spend more or they change monetary policy So they are kind of debasing the currency in effect. Printing money or borrowing money. Yeah, kind of printing money or borrowing money too much. Exactly. And you get a splurge of that crisis. The whole point behind fiscal rules was to try to prevent that from happening. But the reality and the reason I get kind of tense up when I talk about fiscal rules is in practice, the rules are all important until suddenly something happens and then they're not. And then the next person comes along and they introduced new fiscal rules. And it's not like there was ever a crisis in the meantime.

10:03Ed Conway:time. So do we see other kind of chancellors, other heads of exchequers and treasuries around the world struggling with the same issues that Rachel Reeves is? Well, they don't. I mean, for instance, there are no fiscal rules in the United States. But then, I mean, it's a pretty bad example because in the United States right now, they have one of the most scary trajectories for government debt anywhere. But the US is the US. And so they still are able to sell a lot of their debt. They've got a supermassive black hole. They've got a supermassive black hole, to coin a phrase. Yeah. And in other countries, I mean, like there are more and more fiscal rules elsewhere kind of around the world but it's kind of a fad i mean dare i say it's the big fad in recent years is to have fiscal rules and organizations like the office of budget responsibility which are set up as quasi-autonomous bodies which can determine you know what whether you're keeping to the rules and whether you're taking the right policies but here's where i think this is kind of like quite fundamentally interesting we elect and we vote for politicians to make decisions and they make decisions and then decide what taxes we're going to spend in the future.

11:02Ed Conway:And then we think about that and are we happy to pay those taxes and are we happy with the services we're getting? And then the next election, maybe we kick them out because we're not necessarily getting what we want or maybe we keep them in. Injected into that in the last kind of 15 years or so post austerity is this body of unelected officials, the Office of Budget Responsibility primarily, who now have a really influential role within that process. And there is some scrutiny over them. You know, they can be called up in front of Parliament. But I don't think we've kind of had a full enough conversation about how big of a deal that is.

11:36Ed Conway:You've got three unelected people. Ultimately, the OBR is kind of three people primarily who have an incredible amount of importance and influence over government policy right now, because it's those people who are deciding, I don't know, how well they think the economy is doing and how well they think it's doing determines the extra amount of the big black hole. So you are telling me that Rachel Reeves in putting together this budget will be mindful, perhaps maybe not most of all, but certainly a big chunk of her thinking will be what will be the Office for Budget Responsibility's response to this?

12:06Ed Conway:In the run up to this budget, she has already spent some of that time effectively kind of lobbying the OBR and saying, oh, well, we're doing this. Look, we're doing we're doing this economic policy. We're trying to make it easier to build motorways and all of this and railways and stuff. So that should count for something when it comes to economic growth. She's kind of lobbying the OBR to try to give a better growth forecast in the future, which will affect those numbers. So practically, what does the black hole in inverted commas mean for this budget? So this is setting the amount, if she wants to keep to her rules, that she has to either raise taxes or cut spending by.

12:44So it is immensely important.

12:47Ed Conway:Can't she borrow? Why can't she simply borrow her way out of it? Because if she borrows, then she breaks her rules. So the rule is basically saying you can only borrow so much. If she is going to keep to that rule, then she has to find the money from somewhere. If you're not going to borrow, because that's the point, you're going to have to cut spending or raise taxes. And she has already just done her spending rate. She's set spending for the next three years, so she can't do much in the way of dramatic changes to spending. Therefore, everything comes back to taxes. And because she and Keir Starmer in the manifesto has committed themselves not to raising certain types of taxes.

13:19Ed Conway:Income tax, VAT, national insurance. Well, those three taxes between them raise about 60 to 70 percent of all taxes. So if you're going to try and do everything with the little sliver that's left over, then that means you're in pretty kind of desperate territory in fiscal terms. The easy thing to do in these cases, I say easy, it's obviously not easy at all. But if you want to just raise money, the quickest way to do it is to raise VAT by a couple of percentage points or raise either national insurance or income tax. So what did you make then? Rachel Reeves made this really curious speech, I thought, from inside Downing Street.

13:54What did you think of it?

13:56Ed Conway:I think she seemed like she was rolling the pitch and preparing people for the fact that it's quite likely that income tax might go up or indeed that some of the manifesto pledges are going to be broken. So why does she feel beholden to fiscal rules, but not to manifesto promises? I think because she's also conscious that the UK is definitely, I wouldn't say on the precipice, but definitely we're in a vulnerable place when it comes to what the market thinks about our debt right now. So I talked about how if you don't have fiscal rules, then the main discipline is not self-imposed. It's the market.

14:28Ed Conway:And it's people out there, hedge funds a lot of them these days, saying basically, well, we're not going to buy your debt. Or we're going to charge you 5 % or 6 % or 7 % for your debt rather than kind of 2%, 3%, 4%. And the UK right now has the highest bond yields. Those are the interest rates. That's the equivalent. That's how much we've been charged. How much it costs us to borrow money from the market. Exactly. We have the highest rates of any G7 economy right now. Before the mini budget, we were kind of middle of the pack. So what it cost us to borrow was kind of similar to the major other industrialized economies, US, Japan, Canada, the rest.

15:03Ed Conway:Post 2022, suddenly we're top of the pack. Post last year and Labour getting in, not that these two things connected, but around the same time, we went to being an outlier. So we became more expensive. and there was a notable moment after Rachel Rees's first budget where suddenly our borrowing costs spiked higher. It wasn't like the mini budget and I remember it kind of vividly at the time because I remember the mini budget and I remember this moment. It wasn't the mini budget but it was a reaction. It was markets saying we're not sure about this and I think that they in the Treasury, particularly the treasury officials are very sensitive to that and sensitive to the fact that if she steps out and does break the fiscal rules then there is a real possibility of a market reaction that's the worst of all worlds doesn't she genuinely have to think about doing the unthinkable now i mean we talked about the last budget i remember her saying don't worry guys this is it this is the last time i will be coming with cap outstretched for more money we just need to fix it now and then it's going to be growth growth growth that just doesn't work like that so the other thing that we haven't mentioned so far which is all important is that not only did she set herself a fiscal rule when it came to the last budget and the last you know that what happened in the spring so she had another opportunity to look at the numbers rather than giving herself quite a lot of leeway against that rule 20 billion pounds let's say she decided to make it 9.9 billion pounds single figures and that was a miscalculation and a misstep.

16:35Ed Conway:I think if you're going to go out there and say this is the last time we're doing this, you need to have an insurance policy against that. And she didn't have an insurance policy against that. Is she just not very good as Chancellor? You say that she didn't provide herself with enough headroom. Shouldn't she have seen that coming? Single digit billions doesn't sound like enough. I think it's too early to judge whether she's a good or a bad Chancellor. But I think that was definitely a mistake. And I think she would admit in hindsight, that was a mistake. And I think she's ruining it right now.

16:58Ed Conway:I know she's regretting the fact that she didn't leave as much of an insurance policy. I think the government faces a real problem. And I think we may look back in years to come and say that one of the biggest telltale signs that this was not going to go well was that they made big promises about spending cuts. They weren't able to commit to them and now they are facing the consequences of that. Ed, thanks very much indeed. That's your lot for this edition of The Daily. We'll see you again tomorrow. How does a banana trigger a CIA-backed coup? Do AirPods herald the arrival of a new global order?

17:37Ed Conway:What do LED lights say about the future of humanity? I'm Ed Conway, and in each episode of my new podcast, Stuff Matters, I take an object, crack it open, and reveal the world-shaping forces hidden inside. This is economics told through the things we think we understand. Search Stuff Matters on your podcast app to listen and follow. Thank you.