Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum by Mr David Walton, Specialist Adviser to the Committee


  1.  The Chancellor has followed precisely the same approach as that taken in previous years—the unintended overshoot in the budget surplus which has arisen in 2000-01 is given back through some mildly stimulative measures in 2001-02. This leaves the medium term path for the public accounts unchanged from last year's plans.

  2.  Mr Brown has turned his back on the advice of the IMF, who recently argued that there should be no net tax cuts or expenditure increases in this year's Budget. Surprisingly, the IMF implicitly seems to favour using the budget to manage demand over short periods, something which has repeatedly failed in the past. Mr Brown is right to rely instead on an independent central bank to manage demand through changes in interest rates.

  3.  On a fairly wide definition of the measures included in the "Budget", we calculate that the stimulative effect of the package will amount to £5.4 billion, or half a per cent of GDP in 2001-02. The fiscal stance will ease by about 1 per cent of GDP between 2000-01 and the new fiscal year. This will almost exactly offset the unintended tightening in the fiscal stance which has occurred in the year just ended. Hence, the change in fiscal stance over the two years is exactly the same as announced last year.

  4.  As usual, the Chancellor's fiscal projections are based deliberately cautious economic assumptions. In particular, the Treasury continues to assume medium term GDP growth in only 2.25 per cent per annum. On Goldman Sachs' more optimistic assumption of underlying GDP growth of 2.5-3.0 per cent per annum, the Government will have around £10 billion more to "give away" in the new Parliament, while still meeting the fiscal rules with ease.

Maintaining a medium-term focus to fiscal policy

  Prior to the Budget, the IMF Executive Board argued on balance that "it would be prudent for the Government to abstain from introducing new spending commitments or tax cuts in the March 2001 Budget". In the event the Chancellor chose to ignore these calls. The Budget measures consisted of the following:

    —  Implementation of the measures announced for consultation in last November's Pre-Budget Report (PBR). These amount to £2.0 billion in both 2001-02 and 2002-03. (This is on top of the measures announced in the PBR and implemented without further consultation worth £2.6 billion in 2001-02 and £3.9 billion in 2002-03).

    —  Additional Budget measures worth £1.6 billion in 2001-02 and £2.4 billion in 2002-03.

    —  An increase in Departmental Expenditure Limits of £0.8 billion in both 2001-02 and 2002-03. DELs are boosted by a further £1 billion in 2001-02 as this year's estimated underspend is carried forward under the Government's end-year flexibility arrangements.

  Thus, as Exhibit 1 shows, the overall Budget package is worth £4.4 billion in 2001-02 (£5.4 billion if the carryover of this year's £1 billion estimated underspend in departmental spending is included) and £5.2 billion in 2002-03. Although sizeable, these policy measures do nothing more than bring the public finances back broadly on to the course envisaged a year ago. Relative to Budget 2000, PSNB and the surplus on current budget is £1 billion better than expected in 2001-02 and £1-2 billion a year better in future years (see Exhibit 2).

  Many will accuse the Chancellor of indulging in a pre-election giveaway but his actions are entirely consistent with the Government's previous approach to fiscal policy. This was set out clearly by Gus O'Donnell, H.M Treasury's Managing Director of Macroeconomic Policy and International Finance, in evidence to the Treasury Select Committee after the last Budget. He stated that "there is no Government intention to run up surpluses forever. The intention is to move back towards meeting the Golden Rule with a reasonable margin". He likened the situation to a golfer who had hit the ball straight down the fairway when an unanticipated wind comes along and blows the ball to the right. The next shot aims back towards the target.

  In general, I believe that the Chancellor is right to maintain the medium-term focus of fiscal policy. Fiscal policy is not best suited to managing demand, except when there is no alternative (within the EMU, for example), and it is surprising that the IMF is advocating its use. The Government's fiscal rules ensure that the public finances remain on a sustainable footing. Equally, as important, they are transparent—this was one of the easiest Budgets in years to predict because the fiscal framework is clear. Monetary policy is a much better instrument, particularly when in the hands of independent central bankers, to keep overall demand in the economy growing at a pace consisent with maintaining inflation on target.

  There will doubtless be the usual debate about the fiscal stance. The Chancellor argued that the Budgetary measures were prudent because cyclically adjusted net borrowing on the Government's fiscal projections is no greater than in Budget 2000 (see Exhibit 3). Nevertheless the fiscal stance is projected by the Treasury to ease by 1.1 per cent of GDP in 2001-02. A year ago the Treasury expected the fiscal stance to ease by only 0.2 per cent of GDP in 2002-02. But the fiscal stance is only easing by more next year because it tightened by more in 2000-01. This may be no bad thing. The fiscal easing will provide support to the economy over the next couple of years at a time when the global economy is looking fragile.

  The Chancellor's projections are, as usual, based on cautious economic assumptions—in particular, medium-term GDP growth of 2.25 per cent a year. In particular, the Treasury continues to assume medium term GDP growth of only 2.25 per cent per annum. On Goldman Sachs' more optimistic assumption of underlying GDP growth of 2.5-3.0 per cent per annum, the Government will have around £10 billion more to "give away" by 2005-06 while still meeting the fiscal rules with ease (see Exhibit 4).

12 March 2001

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