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Posts Tagged ‘structural budget deficit’

Plus ça change, plus c’est la même chose

The French economy is flatlining. It has just recorded the second quarter of zero economic growth, with growth averaging just 0.02% over the past 12 months. What is more, the budget deficit is rising, not falling. In April this year, the French finance minister said that the deficit would fall from 4.3% in 2013 to 3.8% in 2014 and to the eurozone ceiling of 3% in 2015. He is now predicting that it will rise this year to 4.4% and not reach the 3% target until 2017.

The deficit is rising because a flatlining economy is not generating sufficient tax revenues. What is more, expenditure on unemployment benefits and other social protection is rising as unemployment has risen, now standing at a record 10.3%.

And it is not just the current economic situation that is poor; the outlook is poor too. The confidence of French companies is low and falling, and investment plans are muted. President Hollande has pledged to cut payroll taxes to help firms, but so far this has not encouraged firms to invest more.

So what can the French government do? And what can the EU as a whole do to help revive not just the French economy but most of the rest of the eurozone, which is also suffering from zero, or near zero, growth?

There are two quite different sets of remedies being proposed.

The first comes from the German government and increasingly from the French government too. This is to stick to the austerity plans: to get the deficit down; to reduce the size of government in order to prevent crowding out; and to institute market-orientated supply-side policies that are business friendly, such as reducing business regulation. Business leaders in France, who generally back this approach, have called for reducing the number of public holidays and scrapping the maximum 35-hour working week. They are also seeking reduced business taxes, financed by reducing various benefits.

Increasingly President Hollande is moving towards a more business-friendly set of policies. Under his government’s ‘Responsibility Pact’, a €40 billion package of tax breaks for business will be financed through €50 billion of cuts in public spending. To carry through these policies he has appointed an ex-investment banker, Emmanuel Macron, as economy minister. He replaces Arnaud Montebourg, who roundly criticised government austerity policy and called for policies to boost aggregate demand.

This brings us to the alternative set of remedies. These focus on stimulating aggregate demand through greater infrastructure investment and cutting taxes more generally (not just for business). The central argument is that growth must come first and that this will then generate the tax revenues and reductions in unemployment that will then allow the deficit to be brought down. Only when economic growth is firmly established should measures be taken to cut government expenditure in an attempt to reduce the structural deficit.

There are also compromise policies being proposed from the centre. These include measures to stimulate aggregate demand, mainly through tax cuts, accompanied by supply-side policies, whether market orientated or interventionist.

As Europe continues to struggle to achieve recovery, so the debate is getting harsher. Monetary policy alone may not be sufficient to bring recovery. Although the ECB has taken a number of measures to stimulate demand, so far they have been to little avail. As long as business confidence remains low, making increased liquidity available to banks at interest rates close to zero will not make banks more willing to lend to business, or businesses more willing to borrow. Calls for an end, or at least a temporary halt, to austerity are thus getting louder. At the same time, calls for sticking to austerity and tackling excessive government spending are also getting louder.

Articles
Hollande entrusts French economy to ex-banker Macron Reuters, Ingrid Melander and Jean-Baptiste Vey (26/8/14)
France’s new Minister of the Economy Emmanuel Macron described by left-wingers as a ‘copy-and-paste Tony Blair’ Independent, John Lichfield (28/8/14)
Merkel praises France’s economic reform plans after Berlin talks with PM Valls Deutsche Welle (22/9/14)
French economy flat-lines as business activity falters Reuters, Leigh Thomas (23/9/14)
French public finances: Rétropédalage The Economist (13/9/14)
French employer group urges ‘shock therapy’ for economy Reuters (24/9/14)
Last chance to save France: loosen 35-hour week and cut public holidays, say bosses The Telegraph (24/9/14)
‘Sick’ France’s economy is stricken by unemployment ‘fever’ The Telegraph (17/9/14)
France’s economics ills worsen but all remedies appear unpalatable The Observer, Larry Elliott and Anne Penketh (31/8/14)
The Fall of France The New York Times, Paul Krugman (28/8/14)
Why Europe is terrified of deflation Salon, Paul Ames (20/9/14)
Europe’s Greater Depression is worse than the 1930s The Washington Post, Matt O’Brien (14/8/14)
Worse than the 1930s: Europe’s recession is really a depression The Washington Post, Matt O’Brien (20/8/14)
Eurozone business growth slows in September, PMI survey finds BBC News (23/9/14)
Europe must ‘boost demand’ to revive economy, US warns BBC News (21/9/14)
Valls says France would never ask Germany to solve its problems Reuters, Annika Breidthardt and Michelle Martin (23/9/14)
The euro-zone economy: Asset-backed indolence The Economist (11/9/14)

Data
Annual macro-economic database (AMECO) Economic and Financial Affairs DG, European Commission
Business and Consumer Surveys Times Series Economic and Financial Affairs DG, European Commission
StatExtracts OECD
Statistics database European Central Bank

Questions

  1. What types of supply-side reforms would be consistent with the German government’s vision of solving Europe’s low growth problem?
  2. How could a Keynesian policy of reflation be consistent with getting France’s deficit down to the 3% of GDP limit as specified in the Stability and Growth Pact (see)?
  3. What is meant by (a) financial crowding out and (b) resource crowding out? Would reflationary fiscal policy in France lead to either form of crowding out? How would it be affected by the monetary stance of the ECB?
  4. Give examples of market-orientated and interventionist supply-side policies.
  5. What is meant by the terms ‘cyclical budget deficit’ and ‘structural budget deficit’. Could demand-side policy affect the structural deficit?
  6. Using the European Commission’s Business and Consumer Surveys find our what has happened to business and consumer confidence in France over the past few months.
  7. How important is business and consumer confidence in determining economic growth in (a) the short term and (b) the long term?
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The Autumn Statement about a long cold winter

The Autumn Statement, delivered annually by the Chancellor of the Exchequer in late November or early December, is rather like a second Budget. In his statement, the Chancellor presents new forecasts for the UK economy by the Office for Budget Responsibility (OBR) and announces various policy changes in the light of the forecasts.

So what does this OBR say? Its headline reads, “Government borrowing revised higher as weaker economy hits revenues” and this is followed by the statement:

The OBR has revised up its forecasts for public-sector borrowing over the next five years, as a weaker outlook for the economy reduces tax revenues. As a result, the Government no longer seems likely to achieve its target of reducing public-sector net debt in 2015–16.

The chart shows OBR forecasts for public-sector net borrowing made in June 2010 (its first forecast after the OBR was formed by the Coalition government), in March 2012 and in December 2012. The current forecast clearly shows borrowing set to decline more slowly than in the earlier forecasts. Click here for a PowerPoint of the chart. (Note that the effects of transferring the pension assets of the Royal Mail to the Treasury and the effects of not paying interest to the Bank of England on government bonds purchased under quantitative easing programmes have not been included in order to make the three forecasts consistent.)

So with a weaker economy and slower recovery than previously forecast, what are George Osborne’s options? He and his colleagues, along with various economists, argue for sticking to Plan A. This means continuing with austerity measures in order to get the public-sector deficit down. But with government borrowing having fallen more slowly than forecast, this means further government expenditure cuts, such as reductions in benefits, cuts in grants to local authorities and reductions in pensions relief. Even so, achieving his two targets – (1) eliminating the cyclically adjusted current (as opposed to capital) budget deficit by 2015/16 (the so-called ‘fiscal mandate’), and (2) public-sector debt falling as a proportion of GDP by 2015/16 – will both be missed. They were extended by a year in the Budget last March. They have now been extended by a further year to 2017/18.

The opposition and many other economists argue that Plan A has failed. Austerity has prevented the economy from growing and has thus meant a slower reduction in the deficit as tax revenues have not grown nearly as much as hoped for. A more expansionary policy would allow the deficit to be reduced more quickly, especially if extra government expenditure were focused on infrastructure and other capital spending.

It could be argued that George Osborne’s Autumn Statement moves some way in this direction – a Plan A+. He is making deeper cuts in welfare and government departmental spending in order to divert monies into capital spending. For example, there will be £1bn of extra expenditure on roads; £1bn extra on schools; £270m on FE colleges; and £600m extra for scientific research. Also, by extending the period of austerity to 2017/18, this has meant that he has not had to make even deeper cuts. What is more, he is increasing income tax allowances and cutting the rate of corporation tax by 1% more than originally planned and scrapping the planned 3p per litre rise in road fuel duty. He hopes to make up any lost tax revenue from these measures by HMRC clamping down on tax evasion.

But by sticking to his broad austerity strategy, and with many parts of the global economy having weakened, it looks as if the UK economy is in for several more years of sluggish growth. Winter is going to be long.

Webcasts and Podcasts
Autumn Statement: George Osborne scraps 3p fuel duty rise BBC News, Carole Walker (5/12/12)
Autumn Statement: OBR says deficit ‘shrinking more slowly’ BBC News, Robert Chote (5/12/12)
Autumn Statement: Headlines from George Osborne’s speech BBC News, Andrew Neil (5/12/12)
Autumn Statement: Flanders, Robinson and Peston reactio BBC News, Stephanie Flanders, Nick Robinson and Robert Peston (5/12/12)
Boosting the British Budget CNN, Jim Boulden (5/12/12)
Autumn statement 2012: key points – video analysis The Guardian, Larry Elliott, Jill Treanor, Patrick Collinson and Damian Carrington (5/12/12)

Articles
Autumn Statement 2012: the full speech The Telegraph (5/12/12)
Autumn Statement: Benefit squeeze as economy slows BBC News (5/12/12)
Autumn Statement: At-a-glance summary of key points BBC News (5/12/12/)
Austerity to last until 2018, admits George Osborne Independent, Oliver Wright
Autumn statement: George Osborne reveals benefits cut Channel 4 News (5/12/12/)
Autumn Statement 2012: Cut welfare, create jobs – a very Tory statement The Telegraph, Damian Reece (5/12/12)
Autumn statement 2012: economy weaker than expected, Osborne says The Guardian, Heather Stewart (5/12/12)
Analysis: Even the ‘autumn’ bit seemed optimistic BBC News, Chris Mason (5/12/12)
George Osborne’s autumn statement 2012: reaction The Guardian, Julia Kollewe (5/12/12)
Candid Osborne avoids political risk Financial Times, Janan Ganesh (5/12/12)
Autumn statement: Why George Osborne’s Budget won’t be a game changer The Telegraph, Allister Heath (4/12/12/)
Autumn statement 2012: expert verdict The Guardian, Richard Murphy, Dominic Raab, Ann Pettifor, Gavin Kelly, Prateek Buch and Mark Serwotka (5/12/12/)
The alternative autumn statement Channel 4 News (5/12/12)
Autumn Statement 2012: man cannot live by deficit reduction alone The Telegraph, Roger Bootle (5/12/12)
Autumn statement: cuts are just a sideshow The Guardian, John Redwood (5/12/12)
What does the Autumn Statement mean for business? Economia, David Mellor (5/12/12)
Autumn Statement Reaction: UK AAA ‘safe for today’ Investment Week (5/12/12)
Autumn Statement: A wintry statement of reality BBC News, Stephanie Flanders (4/12/12)
What has changed? BBC News, Stephanie Flanders (6/12/12)
UK warned on debt ‘credibility’ over AAA rating BBC News (5/12/12)

Data
Autumn statement 2012 in charts The Guardian, Simon Rogers (5/12/12/)
Who suffers most from Britain’s austerity? How the figures stack up The Guardian, Tom Clark (5/12/12)
Economic and fiscal outlook charts and tables – December 2012 OBR (5/12/12)
Economic and fiscal outlook supplementary economy tables – December 2012 OBR (5/12/12)
Forecasts for the UK economy HM-Treasury

OBR, Treasury and IFS links
Economic and fiscal outlook – December 2012 OBR (5/12/12)
Autumn Statement 2012 HM Treasury (5/12/12)
Autumn Statement 2012 IFS

Questions

  1. Distinguish between ‘stocks’ and ‘flows’. Define (a) public-sector net borrowing (PSNB) and (b) the public-sector net debt (PSND) and explain whether each one is a stock or a flow.
  2. Summarise the measures announced by George Osborne in his Autumn Statement.
  3. What are his arguments for not adopting a more expansionary fiscal policy?
  4. Assess his arguments.
  5. What is meant by the ‘output gap’? What are the OBR’s forecasts about the output gap and what are the implications?
  6. How has quantitative easing affected PSNB and PSND?
  7. Distinguish between the cyclical and structural deficit. What implications does this distinction have for fiscal policy?
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The path to deficit reduction: following the yellow brick road

There seems to be consensus among most politicians on both sides of the Atlantic that there needs to be a reduction in government deficits and debt as a proportion of GDP. But there is considerable debate as to how such reductions should be achieved.

Conservatives, Republicans and centre right parties in Europe, such as Greece’s Νεα Διμοκρατια (New Democracy) party, believe that there should be tough policies to reduce government expenditure and that the deficit should be reduced relatively quickly in order to retain the confidence of markets.

Politicians on the centre left, including Labour, many Democrats in the USA and centre-left parties in Europe, such as François Hollande’s Socialists, argue that the austerity policies pursued by centre-right governments have led to a decline in growth, which makes it harder to reduce the current deficit.

Then there is debate about what is happening to the structural deficit – the deficit that would remain at a zero output gap. Politicians on the centre right argue that their austerity policies are leading to a rapid reduction in the structural deficit. This, combined with the supply-side policies they claim they are implementing, will allow growth to be resumed more quickly and will increase the long-term growth rate (i.e. the growth in potential output).

Politicians on the centre left argue that deep cuts, by reducing short-term growth (even making it negative in some cases, such as the UK), are discouraging investment and construction. This in turn will lower the growth in potential output and make it harder to reduce the structural deficit.

The following podcast and articles consider these arguments – arguments that are often badly put by politicians, who often use ‘questionable’ economics to justify their party line.

Podcast
A grand economic experiment (also at) More or Less: BBC Radio 4 (first part), Tim Harford (4/5/12) (Programme details)

Articles
The fine art of squeezing: Britain vs America BBC News, Stephanie Flanders (4/5/12)
The Slippery Structural Deficit Wall Street Journal (blog), Matthew Dalton (11/5/12)
The right kinds of austerity policy Financial Times (1/5/12)
We can fix up the old status quo to get out of this mess The Olympian, David Brooks (11/5/12)
Europe’s austerity drive is a misdiagnosis of its problems Gulf News, Joseph Stiglitz (13/5/12)
How Nick Clegg got it wrong on debt Guardian, Polly Curtis (9/5/12)
Ten Reasons Wall Street Should Be (Very) Worried About The U.S. Debt Forbes, Bruce Upbin (4/5/12)

Questions

  1. Distinguish between the structural and cyclical budget deficit.
  2. Explain the distinction between stocks and flows. Which of the following are stocks and which are flows: (a) public-sector deficit; (b) public-sector debt; (c) public-sector net cash requirement; (d) debt reduction; (e) a bank’s balance sheet?
  3. Under what circumstances will a reduction in the public-sector deficit lead to: (a) a reduction in the public-sector debt (total); (b) a reduction in the public-sector debt as a proportion of GDP?
  4. How would you decide what is the desirable level of the public-sector deficit: (a) in the short run; (b) in the long run?
  5. Explain and comment on the following statement from the Stephanie Flanders article: “What is clear is that America has been able to ‘cut its debt (sic) further and faster’ than Britain – but this has not been the result of any closet commitment to austerity. Quite the opposite.”
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A lost decade (or more)

Twice a year, directly after the government’s Spring Budget and Autumn Statement, the Institute for Fiscal Studies gives its verdict on the performance of the economy and the government’s economic policies – past and planned. This year is no exception. After the Chancellor had delivered his Autumn Statement, the next day the IFS published its analysis. And what grim reading it makes.

• Real average (mean) incomes in 2011 will have fallen by 3%.
• Between 2009/10 and 2012/13, real median household incomes will have fallen by 7.4%
• Over the same period, real mean household income will have fallen by 4.7% – easily the biggest 3-year drop since records began in the mid 1950s.
• Real mean household incomes will be no higher in 2015/16 than in 2002/03.
• The poorest will be hardest hit by the measures announced in the Autumn Statement.
• Infrastructure spending of £4bn to £5bn will only go some way offsetting the effects of £17bn capital spending cuts over the Parliament.
• The economy will be 3.5% smaller in 2016 than thought in March.
• The structural budget deficit is 1.6% higher than thought in March.
• That will extend to 6 years the period over which total spending will have been cut year on year.

Referring to this last point, Paul Johnson, director of the IFS, said in his Opening Remarks, “One begins to run out of superlatives for describing quite how unprecedented that is. Certainly there has been no period like it in the UK in the last 60 years.” Referring to the fall in real incomes, he said, “Again we are running out of superlatives to describe just how extraordinary are some of these changes.”

Commentators have referred to the “lost decade” where the average Briton will not have seen an increase in real income.

Articles
Autumn Statement 2011: Families face ‘lost decade’ as spending power suffers biggest fall since 1950s, says IFS The Telegraph, Matthew Holehouse (30/11/11)
Autumn Statement 2011: IFS talks down George Osborne’s growth plan The Telegraph, Philip Aldrick (30/11/11)
Autumn statement study by IFS predicts lost decade for UK living standards Guardian, Katie Allen and Larry Elliott (30/11/11)
Britons Enduring 13-Year Squeeze on Living Standards, IFS Says Bloomberg Businessweek, Gonzalo Vina (30/11/11)
The UK now faces a ‘lost decade’ Financial Times, Martin Wolf (29/11/11)
Warning of seven-year squeeze Independent, James Tapsfield, Andrew Woodcock (30/11/11)
Osborne’s impact laid bare: The rich get richer and the poor get poorer Independent, Ben Chu, Oliver Wright (1/12/11)
Incomes to fall 7.4% in three years, says IFS BBC News (30/11/11)
No growth in income for 14 years, warns IFS BBC News, IFS director Paul Johnson (30/11/11)
UK economy: Third worst year since the war BBC Today Programme, IFS director Paul Johnson (29/11/11)

IFS Analysis
Autumn Statement 2011 and the OBR Economic and Fiscal Outlook IFS (30/11/11)

Questions

  1. Why is it likely that the median real income will have fallen by more than the mean real income?
  2. Why is the structural deficit now estimated to be some 1.6 percentage points higher than was estimated by the OBR back in March 2011?
  3. How could the structural deficit be affected by a prolonged recession? Is this a case of hysteresis?
  4. What are the government’s fiscal rules?
  5. Is the IFS predicting that the rules will be met? What might adversely affect this prediction?
  6. If technological progress is allowing a continuous increase in potential real GDP, why will median real incomes have fallen over the 13 years between 2002/03 and 2015/16? What might have affected long-term aggregate supply adversely?
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Statement of the obvious?

On Tuesday 29 November, the Chancellor of the Exchequer delivered his Autumn Statement. This presented the outlook for the UK economy, with forecasts supplied by the independent Office for Budget Responsibility (OBR). It also contained details of government fiscal measures to tackle various macroeconomic problems, including economic slowdown and high levels of national debt.

The outlook for the UK economy came as no surprise. Things are looking much bleaker than a few months ago. The OBR, along with other forecasters, has downgraded its predictions of the UK’s growth rate. Although it is still forecasting positive growth of 0.9% this year and 0.7% in 2012, these rates are well below those it predicted just eight months ago. In March it forecast growth rates of 1.7% for 2011 and 2.5% for 2012.

To make things worse, its growth forecasts are based on the assumptions that the eurozone crisis will be resolved with little or no effect on the UK. But even if that were so, the debt reduction plans in the eurozone are likely to drive the eurozone back into recession. This, in turn, will impact on UK exports, more than 50% of which go to eurozone countries.

The OBR forecasts that national debt will be 67% of GDP this year and will rise to 78% by 2014/15 but then start to fall. Government borrowing is forecast to be £127bn this year, falling to £120bn in 2012/13 and then more substantially each year after that to £24bn in 2016/17.

So what measures were included in the Autumn Statement? These are detailed in the articles below, but the key ones were:

• a programme of credit easing, which will underwrite up to £40bn in low-interest loans for small and medium-sized businesses.
• £5bn of public money to be invested in infrastrucuture projects and a further £5bn in the next spending round. Agreement had been reached with two groups of pension funds to invest a further £20bn of private money in infrastructure projects.
• an additional £1.2bn for capital investment in schools.
• A cap on public-sector pay increases of 1% per year for the two years after the current two-year pay freeze.

The following videos and articles give details of the forecasts and the measures and give reactions from across the political spectrum.

Webcasts
George Osborne: Key points from chancellor’s speech BBC News, Andrew Neil 29/11/11)
Autumn Statement 2011: George Osborne – my plan to ‘see Britain through The Telegraph on YouTube (29/11/11)
UK economy slows to crawl Reuters (29/11/11)
George Osborne’s autumn statement – video analysis Guardian, Larry Elliott (29/11/11)
Autumn Statement: Osborne reveals state of UK economy BBC News, Nick Robinson (29/11/11)
Autumn Statement: Why is the deficit not shrinking? BBC News, Hugh Pym (29/11/11)
Autumn Statement: Robinson, Flanders and Peston analysis BBC News, Nick Robinson, Stephanie Flanders and Robert Peston (29/11/11)
Can the UK economy be ‘re-balanced’? BBC Newsnight, Paul Mason (29/11/11)

Articles
Autumn Statement 2011: main points The Telegraph, Rachel Cooper (29/11/11)
The Autumn Statement at a glance WalesOnline, Rhodri Evans (30/11/11)
Autumn Statement Summary 2011 TaxAssist Accountants (29/11/11)
Into the storm The Economist (3/13/11)
A battalion of troubles The Economist (3/12/11)
Weapons of mass construction The Economist (3/12/11)
Mr Osborne’s unwelcome statement BBC News, Stephanie Flanders (29/11/11)
£30bn of extra cuts keep Osborne on track, just BBC News, Paul Mason (29/11/11)
Autumn Statement 2011: Commentators give their verdict The Telegraph (30/11/11)
Autumn Statement 2011: concern remains but ‘Plan A-plus’ welcomed The Telegraph, Graham Ruddick (29/11/11)
Autumn statement: George Osborne’s cutting fantasy is over Guardian, Robert Skidelsky (29/11/11)
Hoarding for the apocalypse? I really wouldn’t blame you Guardian, Zoe Williams (30/11/11)

Reports and data
Autumn Statement 2011 – documents HM Treasury (29/11/11)
Economic and fiscal outlook – November 2011 Office for Budget Responsibility (29/11/11)
Autumn statement 2011: the key data you need to understand George Osborne’s speech Guardian DataBlog (29/11/11)
How much will the autumn statement cost and how will the economy change? Guardian DataBlog (29/11/11)

Questions

  1. Compare the OBR’s March and November 2011 forecasts.
  2. What factors explain the differences in the two sets of forecasts?
  3. For what reasons might national debt in the future turn out to be higher or lower than that forecast by the OBR?
  4. What will be the impact on aggregate demand of the measures announced in the Autumn Statement?
  5. What will be the impact on aggregate supply of the measures announced in the Autumn Statement?
  6. Why may a recession impact not just on aggregate demand but also on long-term aggregate supply?
  7. Why may increased pessimism by both consumers and producers make it more difficult for the government to meet its macroeconomic objectives?
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What’s £81.6 billion and still rising?

So what’s £81.6 billion and still rising? The answer is the UK public-sector budget deficit so far this financial year. Given all the talk over the past week about the state of the Irish public finances it is perhaps timely to review the state of the UK public finances. To do this we take a look at the latest release of public sector finances from the Office for National Statistics. It is worth pointing out that the figures we will refer to take into account the impact of those financial interventions which were designed to ensure the stability of the financial system following the financial crisis. These interventions include the transfer of financial institutions like Northern Rock and HBOS to the public sector, injections of capital into financial institutions and the Asset Protection Scheme whereby institutions insured themselves against losses on assets placed in the scheme. The main impact of these interventions has been on the overall stock of public-sector debt following the incorporation of some financial institutions into the public sector.

We consider three key statistics of the public finances. Firstly, we consider the UK’s level of net borrowing. This is a flow concept measuring the degree to which the public sector’s expenditures exceed its receipts. In October net borrowing was recorded at £10.3 billion and, as we said at the outset, this takes the level of net borrowing so far this financial year (i.e. since April) to £81.6 billion. This compares with £87.5 billion in the same period in 2009. If all these numbers leave you a tad cold then perhaps it may help to note that since the beginning of January 2009 the public sector has been running an average monthly deficit of around £12 billion.

Another widely quoted fiscal indicator is the public-sector current budget. The current budget measures whether the public sector has been able to afford what are known as current expenditures and so net investment by the public sector is excluded from this fiscal indicator. Current expenditures include the wages of public sector staff, such as teachers and nurses, welfare payments and expenditures on a whole range of inputs consumed in the current financial year. Net investment by the public sector adds to our country’s capital stock and includes expenditures on such things as roads and school buildings as well as investment grants to the private sector, for example money to help better insulate our homes.

The public sector’s current budget was in deficit in October to the tune of £7.1 billion. This means that in the current financial year the current budget deficit has reached £64.1 billion which compares with £69.1 billion in the same period last year. Again to put the current budget into perspective we note that since January 2009 the average current budget deficit has been running at just under £8 billion per month.

The third key statistic reported by the ONS is public-sector net debt. This is the value of the sector’s stock of debt less its liquid financial assets (largely foreign exchange reserves and bank deposits). As of the end of October, the stock of net debt (excluding the impact of the financial interventions) stood at £845.8 billion, equivalent to 57.1% of GDP. If we include the impact of the financial interventions then the stock of public sector debt at the end of October was actually £955 billion and so not too far off the £1 trillion-mark. This figure is equivalent to 64.5% of GDP and shows quite clearly the impact of incorporating the balance sheets of those financial institutions now classified as public monetary and financial institutions.

But what about the future prospects for our 3 key indicators of the public finances. The Office for Budget Responsibility central projections at the time of the June Budget predicted that the government’s fiscal consolidation plan will see the current budget in balance across financial year 2015/16. This is expected to come about as the current budget deficit begins falling each year following the current financial year. It is also predicts that if we take into account the negative impact of the economy’s expected negative output gap on the public finances that the structural current budget deficit will have been removed by 2014/15. In other words, any current budget deficit in 2014/15 will be a cyclical deficit resulting from higher expenditure and/or lower receipts because of the economy’s actual output being below its potential output.

Of course, while the OBR is predicting that the actual current budget (i.e. without any adjustment for the cycle) will be in balance by 2015-16, this still means that the public sector will remain a net borrower because there is also net investment expenditure to take into account. Nonetheless, if the forecast is proved correct, this would see net borrowing across the whole of 2015-16 of only £20 billion. As for net debt, the OBR is predicting that it will peak at 70.3% of GDP in 2013-14 before falling to 69.4% by 2014-15.

Articles
U.K. had larger-than-expected budget deficit in October amidst modest growth Bloomberg, Svenja O’Donnell (18/11/10)
UK Oct public sector borrowing rise more than expected International Business Times, (18/11/10)
UK government borrowing at £10.3 billion in October BBC News (18/11/10) )
Deficit target still in sight despite new UK borrowing high Telegraph , Emma Rowley (18/11/10)
UK public sector borrowing rises Sky News, Goldie Momen Putrym (18/11/10)
Britain slumps another £10 billion in the red Independent, Holly Williams (18/11/10)

Data
Latest on Public Sector Finances Office for National Statistics (20/11/10)
Public Sector Finances Statistical Bulletin, October 2010 Office for National Statistics (20/11/10)
Public Sector Finances (First Release) Time Series Data Office for National Statistics
Public Sector Finance Statistics HM Treasury

Questions

  1. What do you understand to be the difference between the concepts of deficits and debt? Illustrate your answer with reference to the public sector and a household’s finances.
  2. What types of public expenditures would be categorised as being current expenditures and what types as capital expenditures?
  3. What is the difference between the current budget and net borrowing? Why might governments want to measure both these budget balances?
  4. Explain what you think is meant by a cyclical deficit and a structural deficit? Can you have cyclical surpluses and structural surpluses?
  5. What is meant by an output gap? What impact would you expect an output gap to have on the public finances?
  6. In 1988/89 the UK ran a budget surplus equivalent to 6.3% of GDP. After cyclically-adjusting this surplus is estimated to have been a deficit with net borrowing equivalent to 1.3% of GDP. Can you explain how this is possible and what the economy’s output gap is likely to have been?
  7. Imagine that you have been asked by government to design either a fiscal rule (or rules) or a set of principles for fiscal policy. What sorts of considerations would you take into account and so what rule or principles, if any, would you suggest?
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A Budget emergency

A large deficit which needs cutting and this needs decisive action. This was the gist of the message from George Osborne, and generally from the Coalition government. Although there is nothing confirmed in terms of what to expect, it is thought that there will be a proposal to ease National Insurance for new businesses. He said:

“And so we’ve got to deal with that [the country in Europe with the largest budget deficit of any major economy]. In that sense it’s an unavoidable Budget, but what I’m determined to do is to make sure that the measures are tough but they’re also fair and that we’re all in this together and that, as a country, we take the steps necessary to actually provide the prosperity for the future.”

We already know that there are plans in place to increase capital gains tax from 18% to nearer 40%, but beyond that, little is known. There are concerns that this policy may actually cost the government more in tax revenue than it will raise. Other policies we might expect include a rise in VAT, and a slashed spending budget for pensions. These spending cuts and tax rises will help Osborne to eliminate the structural deficit in current spending by 2015, when the Coalitions’ current term comes to an end. The success of the Coalition’s policies and their ability to reduce the deficit without causing the economy to fall back into recession will be crucial in determining whether the current term is the only term.

Budget 2010: Britain on ‘road to ruin’ without cuts (including video) BBC News (20/6/10)
Where could spending axe fall? BBC News (9/6/10)
George Osborne says emergency budget cuts will be ‘tough but fair’ Guardian, Larry Elliott, Toby Helm, Anushka Asthana and Maev Kennedy (20/6/10)
Budget 2010: capital gains tax Telegraph (20/6/10)
What’s the Chancellor planning to take away in reverse Christmas budget Independent, Alison Shepherd and Julian Knight (20/6/10)
Public borrowing at a peak, says ONS, but tough budget awaits Independent, Sean O’Grady (20/6/10)
A bloodbath none was prepared for Financial Times, Martin Wolf (22/6/10)

Questions

  1. To what extent is it necessary to cut the budget deficit now and not delay it until the recovery is more secured?
  2. How will easing National Insurance for small businesses affect the economy?
  3. If capital gains tax goes up, why is there concern that this could actually cost the government? How is this possible?
  4. The Lib Dems will oppose any increase in VAT, as they argue it is a regressive tax. What does this mean?
  5. How will the report by the Office for Budget Responsibility have affected Osborne’s emergency budget?
  6. What is the structural budget deficit? Illustrate it on a diagram.
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The route to recovery: alternative paths

With an election approaching, there is much debate about recovery and cuts and about the relationships between the two. Will rapid cuts stimulate confidence in the UK by business and bankers and thereby stimulate investment and recovery, or will they drive the economy back into recession? The debate is not just between politicians vying for your vote; economists too are debating the issue. Many are taking to letter writing.

In the February 2010 news blog, A clash of ideas – what to do about the deficit, we considered three letters written by economists (linked to again below). There has now been a fourth – and doubtless not the last. This latest letter, in the wake of the Budget and the debates about the speed of the cuts, takes a Keynesian line and looks at the sustainability of the recovery – including social and environmental sustainability. It is signed by 34 people, mainly economists.

Letter: Better routes to economic recovery Guardian (27/3/10)
Letter: UK economy cries out for credible rescue plan Sunday Times, 20 economists (14/2/10)
Letter: First priority must be to restore robust growth Financial Times, Lord Skidelsky and others (18/2/10)
Letter: Sharp shock now would be dangerous Financial Times, Lord Layard and others (18/2/10)

Questions

  1. Summarise the arguments for making rapid cuts in the deficit.
  2. Summarise the arguments for making gradual cuts in the deficit in line with the recovery in private-sector demand.
  3. Under what conditions would the current high deficit crowd out private expenditure?
  4. What do you understand by a ‘Green New Deal’? How realistic is such a New Deal and would there be any downsides?
  5. Is the disagreement between the economists the result of (a) different analysis, (b) different objectives or (c) different interpretation of forecasts of the robustness of the recovery and how markets are likely to respond to alternative policies? Or is it a combination of two of them or all three? Explain your answer.
  6. Why is the effect of the recession on the supply-side of the economy crucial in determining the sustainability of a demand-led recovery?
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A cool look at the Budget

After each Budget, the Institute for Fiscal Studies analyses its effects. Given the highly charged political environment, with an election looming and the prospects of considerable public expenditure cuts to come, dispassionate analyses of the Budget are hard to find. The IFS’s analysis is a major exception.

The IFS summarises the Budget as being largely neutral. As Robert Chote, Director of the IFS, says in the opening remarks to the Post Budget Briefing:

In a Pre-Election Budget, perhaps the most that we can expect of any Chancellor is that he should observe the key tenet of the Hippocratic Oath and “above all, do no harm”. Judged against that modest yardstick, the broadly neutral stance of this Budget passes the test.

But, the Budget avoided giving details of the cuts which are planned for the future. None of the political parties are saying just how they will achieve the necessary reductions to the deficit, although the Liberal Democrats have given some details.

Judged against the more testing yardstick of providing a detailed picture to voters and financial market participants of the fiscal repair job in prospect beyond the election, the Budget will have fallen short of many people’s hopes. There are an awful lot of judgements still to be made, or revealed, notably with regards public spending over the next parliament. This greater-than-necessary vagueness allows the opposition to be vaguer than necessary too.

The articles below look at the Budget and at the IFS’s assessment of it. There are also links to the sections of the IFS report. It is worth reading them if you are to be able to make the ‘cool’ judgements that economists can provide – even if they do not always agree!

Articles
Budget leaves questions unanswered – IFS Reuters (25/3/10)
Budget 2010: IFS warns transport and housing spending has to be cut Guardian, Phillip Inman (25/3/10)
Labour ‘has cost the rich £25,000 every year’ Independent, Sean O’Grady (26/3/10)
The pain to come The Economist (25/3/10)
Chancellor’s ‘difficult balancing act’ BBC Today Programme (24/3/10)
Pain deferred until the polls close Financial Times, Chris Giles (25/3/10)

IFS Report: Budget 2010
Links to the various supporting articles and the opening remarks can be found here.

Details of the Budget
See references in Darling and a case of fiscal drag? for details of the Budget measures.

Questions

  1. What do you understand by the ‘structrual’ deficit and the ‘cyclical’ deficit?
  2. Why do cyclical deficits rise during a recession?
  3. Why has the structural deficit risen during this recession? Is this an example of hysteresis? (Explain.)
  4. What is the Fiscal Responsibility Act and why does the government now expect to over-achieve the requirements of the Act?
  5. What elements of government spending are likely to be cut most? Is this a wise distribution of cuts?
  6. Use the links to the PowerPoint presentations from the IFS Budget Report site to (a) analyse the state of the public finances; (b) summarise the main tax changes in the Budget.
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A clash of ideas – what to do about the deficit

On February 14, the Sunday Times published a letter by 20 eminent economists calling on the next government to cut the public-sector deficit more rapidly than that planned in last December’s pre-Budget report.

In order to minimise this risk and support a sustainable recovery, the next government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-Budget report.

The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.

Then on 18 February the Financial Times published two letters, between them from more than 60 economists, backing Alistair Darling’s policy of delaying cuts until the recovery is firmly established. They openly disagreed with the 20 economists who wrote to the Sunday Times.

… while unemployment is still high, it would be dangerous to reduce the government’s contribution to aggregate demand beyond the cuts already planned for 2010-11 (which amount to 1 per cent of gross domestic product). Further immediate cuts – even supposing they are practicable – would not produce an offsetting increase in private sector aggregate demand, and could easily reduce it. History is littered with examples of premature withdrawal of the government stimulus, from the US in 1937 to Japan in 1997. With people’s livelihoods at stake, a responsible government should avoid reckless actions.

… A sharp shock now would not remove the need for a sustained medium-term programme of deficit reduction. But it would be positively dangerous. If next year the government spent less and saved more than it currently plans, this would not “make a sustainable recovery more likely”. The weight of evidence points in the opposite direction.

So why do such eminent economists have apparently such divergent views on tackling the public-sector deficit? Is there any common ground between them? What does the disagreement imply about the state of macroeconomics? Read the letters and articles and then try answering the questions.

Tories right on cuts, say economists Sunday Times, David Smith (14/2/10)
Letter: UK economy cries out for credible rescue plan Sunday Times, 20 economists (14/2/10)
Economists reject calls for budget cuts Financial Times, Jean Eaglesham and Daniel Pimlott (18/2/10)
Letter: First priority must be to restore robust growth Financial Times, Lord Skidelsky and others (18/2/10)
Letter: Sharp shock now would be dangerous Financial Times, Lord Layard and others (18/2/10)
Economists urge swift action to reduce budget deficit BBC News (14/2/10)
Economists back delay on government spending cuts BBC News (19/2/10)
Economists back delay on government spending cuts BBC News (19/2/10)
Men of letters III BBC News blogs: Stephanomics, Stephanie Flanders (19/2/10)
Daily View: When to cut spending? (including podcast) BBC News blogs, Clare Spencer (19/2/10)
Cautious economists and cutters battle it out in print Guardian (20/2/10)
The great economics rift reopens Guardian, Gavyn Davies (19/2/10)
Focus on growth. Don’t argue about cuts Times Online, Eamonn Butler (20/2/10)
Recession’s ruins hide plenty of spare capacity Sunday Times, David Smith (14/2/10)

Questions

  1. To what extent is the disagreement between the two sets of economists largely one of the timing of the cuts?
  2. Is the disagreement the result of (a) different analysis, (b) different objectives or (c) different interpretation of forecasts of the robustness of the recovery and how markets are likely to respond to alternative policies? Or is it a combination of two of them or all three? Explain your answer.
  3. How would new classical economists respond to the Keynesian argument that it is necessary to focus on aggregate demand if the economy is to experience a sustained recovery?
  4. How would Keynesian economists respond to the argument that rapid cuts will reassure markets and allow private-sector recovery to more than compensate for reduced public-sector activity?
  5. Why is the effect of the recession on the supply-side of the economy crucial in determining the sustainability of a demand-led recovery?
  6. Distinguish between the cyclical and structural deficits. How would the policies advocated by the two groups of economists impact on the structural deficit?
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