Wednesday 5 December 2012

The Autumn Statement and the OBR's forecasts: recovery postponed, again

Just as talk about a "double-dip recession" after the unusually bad second quarter growth figures was overdone, so was the euphoria about Britain "surging out of recession" after the third quarter figures.  The official forecasts from the Office of Budget Responsibility today are for growth of 1.2 percent in 2013 and 2 percent in 2014; very similar to NIESR's forecast.  These, further downgraded, forecasts mean the economy won't be growing faster than trend until 2015.  So the underlying picture remains much the same as it has for the last two years - slow (or no) growth, and certainly nothing like the sustained recovery we should have seen by now. 

What explains this poor performance?   The lack of an appropriate policy response to the impaired financial system, both here and globally, is impairing the flow of credit to the real economy, limiting the effectiveness of monetary policy and slowing the necessary deleveraging in the private sector. And this in turns has aggravated the impact  of premature austerity, both in the UK and, even more damagingly, in the eurozone.   In particular, the very sharp cuts in public investment - down by almost half in the last two years - have clearly had a substantial negative impact.

Nothing in the Autumn Statement materially changes this picture.  The increases in infrastructure spending are welcome - not least because they constitute an implicit recognition that the previous cuts (to be fair, largely a continuation of the plans of the previous government) were a damaging mistake. However, the scale of the additional spending - £5 billion, or 0.3% of GDP - is insufficient to provide a significant boost to output and employment in the short term (the OBR estimates the net impact on growth might be 0.1%).  As I've pointed out before, at current long-term interest rates, we could fund a £30 billion infrastructure spending programme - 2% of GDP, enough to make a real difference - with the revenues raised from the pasty tax. 

Moreover, from an economic perspective, it is unfortunate that the money has been found in part by cutting tax credits and welfare benefits.  For obvious reasons, such benefits rise faster in a downturn than when the economy is doing well.  And that is one of the main reasons why the deficit has fallen so much more slowly than the government had hoped two years ago.  But that's not a bug; it's a feature; the "automatic stabilisers", as they are known to economists, help dampen the economy in booms and boost it in recessions.   Indeed, the Chancellor has previously argued precisely this 
"That is why the automatic stabilisers and the ability of monetary policy to respond are key parts of the flexibility built in to our plan."
But cutting welfare benefits deliberately negates, as a matter of policy, the operation of the automatic stabilisers; it is a reduction in flexibility, not an increase.  It is unclear why he has chosen to disregard his own advice - and indeed that of the IMF, which has argued repeatedly for the "free operation of the automatic fiscal stabilisers." 

So, finally, what about the deficit?  The Autumn Statement confirms that ultimately self-defeating austerity is just that.  Weaker tax revenues, the result of weak growth, mean that the government's original fiscal targets are now unachievable.  The government's original plan was to eliminate the cyclically adjusted current budget deficit in four years, by 2014-15. The OBR now forecast that (adjusting for various accounting changes) this will be achieved in 2017-18 - five years from now.  In other words, two and a half years on from the start of the fiscal consolidation plan, we are farther away from balancing the budget than when we started.

Meanwhile, the OBR has also stated that the government is not on track to hit the "supplementary" target of reducing the debt to GDP ratio by 2015-16.  Thankfully, the Chancellor recognised that announcing further spending cuts or tax rises in an attempt to hit this target would just do further unnecessary economic damage.  But this does have broader implications for the fiscal framework overall.  The "supplementary" target is often presented as a less important add-on to the primary target. But, as I've argued before, this is a misunderstanding; the two are closely related.  As the 2010 Budget put it:
"At this time of rapidly rising debt, the fiscal mandate will be supplemented by a target for public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16, ensuring that the public finances are restored to a sustainable path.  This fiscal mandate, supplemented by the target for debt, will guide fiscal policy decisions over the medium term, ensuring that the Government sets plans consistent with accelerating the reduction in the structural deficit so that debt as a percentage of GDP is restored to a sustainable, downward path."
So without the debt target, the central element of the fiscal framework - the deficit reduction target - is no longer credible or coherent. NIESR has always argued that, while the government's fiscal consolidation plan was unnecessarily front-loaded, with the damaging consequences now visible, a medium to long term framework to ensure fiscal sustainability was both necessary and desirable.  We need a new one; as the IFS has already proposed, it would be sensible for the government to announce a proper consultation on this topic. 

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