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
- Compare the OBR’s March and November 2011 forecasts.
- What factors explain the differences in the two sets of forecasts?
- For what reasons might national debt in the future turn out to be higher or lower than that forecast by the OBR?
- What will be the impact on aggregate demand of the measures announced in the Autumn Statement?
- What will be the impact on aggregate supply of the measures announced in the Autumn Statement?
- Why may a recession impact not just on aggregate demand but also on long-term aggregate supply?
- Why may increased pessimism by both consumers and producers make it more difficult for the government to meet its macroeconomic objectives?
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
- 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.
- What types of public expenditures would be categorised as being current expenditures and what types as capital expenditures?
- What is the difference between the current budget and net borrowing? Why might governments want to measure both these budget balances?
- Explain what you think is meant by a cyclical deficit and a structural deficit? Can you have cyclical surpluses and structural surpluses?
- What is meant by an output gap? What impact would you expect an output gap to have on the public finances?
- 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?
- 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?
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
- To what extent is it necessary to cut the budget deficit now and not delay it until the recovery is more secured?
- How will easing National Insurance for small businesses affect the economy?
- If capital gains tax goes up, why is there concern that this could actually cost the government? How is this possible?
- The Lib Dems will oppose any increase in VAT, as they argue it is a regressive tax. What does this mean?
- How will the report by the Office for Budget Responsibility have affected Osborne’s emergency budget?
- What is the structural budget deficit? Illustrate it on a diagram.
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
- Summarise the arguments for making rapid cuts in the deficit.
- Summarise the arguments for making gradual cuts in the deficit in line with the recovery in private-sector demand.
- Under what conditions would the current high deficit crowd out private expenditure?
- What do you understand by a ‘Green New Deal’? How realistic is such a New Deal and would there be any downsides?
- 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.
- Why is the effect of the recession on the supply-side of the economy crucial in determining the sustainability of a demand-led recovery?
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
- What do you understand by the ‘structrual’ deficit and the ‘cyclical’ deficit?
- Why do cyclical deficits rise during a recession?
- Why has the structural deficit risen during this recession? Is this an example of hysteresis? (Explain.)
- What is the Fiscal Responsibility Act and why does the government now expect to over-achieve the requirements of the Act?
- What elements of government spending are likely to be cut most? Is this a wise distribution of cuts?
- 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.