The diminished role of the Budget
Wednesday, 19 March 2008
Samuel Brittan
BRITISH Budgets are not what they were. Much of the job of steering the economy has shifted from fiscal to monetary policy and therefore to the Bank of England. Interest rates and exchange rates now play a greater role than the modest changes in taxes and spending that used to be the centrepiece of economic policy. In fiscal policy itself the fine-tuning philosophy has been replaced by long-term guidelines. The main influence on the tax-take is now the public expenditure review, which is supposed to determine spending three years ahead and is published at a different time to the chancellor's Budget statement. The latter must, in Bagehot's terminology, now be regarded as part of the dignified rather than the effective part of economic policy.
These underlying factors have been reinforced this year by the worldwide credit crunch. Even the greatest fiscal nostalgic will have to admit that both the world and the UK economic outlook depend far more on the success of the efforts of the US Federal Reserve and other central banks to inject funds into the banking system than on modest fiscal adjustments in any one European country. If these efforts succeed and worldwide financial pressures begin to ease in the second half of this year, as the Treasury documents assume, then the overall shape of the Budget is right, whatever one thinks of the control freak adjustments of detail so beloved by Gordon Brown, the prime minister. The UK economy is already working close to capacity, inflationary expectations have increased and there is no case for a discretionary stimulus.
It is remarkable that for all its forebodings of economic slowdown the official forecast only shows a deterioration in gross domestic product growth from 3.0 per cent in 2007 to 2.0 per cent this year, followed by a return to trend in 2009. We should be so lucky. In any case, Alistair Darling has responded by allowing public sector borrowing to rise from 2.3 per cent of GDP in 2006-07 to 2.6 per cent this year and 2.9 per cent in 2008-09, mainly as a result of the so-called automatic stabilisers, followed by a gradual fall back to 1.3 per cent by 2012-13.
Some analysts have had fun comparing these numbers with the original projections with which Mr Brown started out a few years ago. But they are still well within the limits of fiscal solvency as defined, for instance, for European commitments. The most interesting aspect of the official forecast is a hint of the much discussed "rebalancing" of the economy with growth in 2008 not being led by consumption and net exports at last making a contribution. But before cheering too hard, recall that there were the beginnings of such a change in 2005 only to be reversed in subsequent years.
Keeping our fingers crossed on the risks of financial meltdown does not, however, amount to a strategy. Every responsible businessperson and economic policymaker must be contemplating what will happen if contractionary pressures increase and we are faced with a bigger slowdown than anything in the mainline forecasts. We are fortunate that Ben Bernanke, chairman of the Fed, is a close student of the Great Depression and is determined to prevent anything like it happening again.
By contrast, any writer in a financial paper is bombarded with claims that the old remedies no longer work, the textbooks are out of date and so on. Those who say this rarely tell us what these remedies are or provide quotes from any textbook. If I have any role in this discussion it is to get away from the technical complexities and to look at underlying issues. An economic depression reflects a shortfall of spending relative to the capacity to produce. It can be offset by injections of money from the the central bank or the government, preferably working together.
Faced with an emergency, the fiscal guidelines should and would be sidelined. The scoffers will say that both businesspeople and ordinary consumers will be too nervous to spend official handouts. This surely depends on how large they are. I refuse to believe that, if the streets of Manhattan and the City of London were paved with money dropped from helicopters, none of this would be picked up and spent. Indeed, the fear that such droppings will be inflationary should be an inducement to spend before prices shoot upwards.
We frequently hear that the citizens of English-speaking countries have accumulated excessive amounts of debt. If this is so, it makes a case for putting the emphasis on tax cuts in fighting a really severe recession. For monetary easing works by encouraging people to borrow more. In the case of fiscal policy, the debts are incurred by the state, which, provided it behaves sensibly, is not nearly so vulnerable.
In fact, there is a danger that governments and central banks, especially on the eastern side of the Atlantic, confuse the present inflationary threat from oil and commodity prices with the internally generated wage price spiral of earlier decades. The different targets and time scales required to respond to the very different present inflationary threat must be a subject for a separate article.
.........................................
FT Syndication Service
BRITISH Budgets are not what they were. Much of the job of steering the economy has shifted from fiscal to monetary policy and therefore to the Bank of England. Interest rates and exchange rates now play a greater role than the modest changes in taxes and spending that used to be the centrepiece of economic policy. In fiscal policy itself the fine-tuning philosophy has been replaced by long-term guidelines. The main influence on the tax-take is now the public expenditure review, which is supposed to determine spending three years ahead and is published at a different time to the chancellor's Budget statement. The latter must, in Bagehot's terminology, now be regarded as part of the dignified rather than the effective part of economic policy.
These underlying factors have been reinforced this year by the worldwide credit crunch. Even the greatest fiscal nostalgic will have to admit that both the world and the UK economic outlook depend far more on the success of the efforts of the US Federal Reserve and other central banks to inject funds into the banking system than on modest fiscal adjustments in any one European country. If these efforts succeed and worldwide financial pressures begin to ease in the second half of this year, as the Treasury documents assume, then the overall shape of the Budget is right, whatever one thinks of the control freak adjustments of detail so beloved by Gordon Brown, the prime minister. The UK economy is already working close to capacity, inflationary expectations have increased and there is no case for a discretionary stimulus.
It is remarkable that for all its forebodings of economic slowdown the official forecast only shows a deterioration in gross domestic product growth from 3.0 per cent in 2007 to 2.0 per cent this year, followed by a return to trend in 2009. We should be so lucky. In any case, Alistair Darling has responded by allowing public sector borrowing to rise from 2.3 per cent of GDP in 2006-07 to 2.6 per cent this year and 2.9 per cent in 2008-09, mainly as a result of the so-called automatic stabilisers, followed by a gradual fall back to 1.3 per cent by 2012-13.
Some analysts have had fun comparing these numbers with the original projections with which Mr Brown started out a few years ago. But they are still well within the limits of fiscal solvency as defined, for instance, for European commitments. The most interesting aspect of the official forecast is a hint of the much discussed "rebalancing" of the economy with growth in 2008 not being led by consumption and net exports at last making a contribution. But before cheering too hard, recall that there were the beginnings of such a change in 2005 only to be reversed in subsequent years.
Keeping our fingers crossed on the risks of financial meltdown does not, however, amount to a strategy. Every responsible businessperson and economic policymaker must be contemplating what will happen if contractionary pressures increase and we are faced with a bigger slowdown than anything in the mainline forecasts. We are fortunate that Ben Bernanke, chairman of the Fed, is a close student of the Great Depression and is determined to prevent anything like it happening again.
By contrast, any writer in a financial paper is bombarded with claims that the old remedies no longer work, the textbooks are out of date and so on. Those who say this rarely tell us what these remedies are or provide quotes from any textbook. If I have any role in this discussion it is to get away from the technical complexities and to look at underlying issues. An economic depression reflects a shortfall of spending relative to the capacity to produce. It can be offset by injections of money from the the central bank or the government, preferably working together.
Faced with an emergency, the fiscal guidelines should and would be sidelined. The scoffers will say that both businesspeople and ordinary consumers will be too nervous to spend official handouts. This surely depends on how large they are. I refuse to believe that, if the streets of Manhattan and the City of London were paved with money dropped from helicopters, none of this would be picked up and spent. Indeed, the fear that such droppings will be inflationary should be an inducement to spend before prices shoot upwards.
We frequently hear that the citizens of English-speaking countries have accumulated excessive amounts of debt. If this is so, it makes a case for putting the emphasis on tax cuts in fighting a really severe recession. For monetary easing works by encouraging people to borrow more. In the case of fiscal policy, the debts are incurred by the state, which, provided it behaves sensibly, is not nearly so vulnerable.
In fact, there is a danger that governments and central banks, especially on the eastern side of the Atlantic, confuse the present inflationary threat from oil and commodity prices with the internally generated wage price spiral of earlier decades. The different targets and time scales required to respond to the very different present inflationary threat must be a subject for a separate article.
.........................................
FT Syndication Service