Memorandum submitted by Mr Martin Weale,
National Institute of Economic and Social Research
A. Government Borrowing and the Fiscal Rules
1. The Pre-budget Report shows the
Golden Rule, that over the cycle the government should borrow
only to invest, and run a balance or surplus on the current account,
being met by £3 billion if the cycle ends in March 2005 and
broken by £4 billion if the cycle ends in March 2006.
2. The Treasury calculations, showing that
the rule will be met even if the cycle ends in 2006, are incorrect
because they involve aggregating surpluses and deficits as proportions
of GDP rather than simply adding up money borrowed or saved. This
has the effect of uprating surpluses early in the cycle. Such
uprating is wrong because the interest accruing on the surpluses
is separately counted as income in subsequent years.
3. The Pre-Budget Report (Box A3)
recognises the difficulties in measuring the economic cycle until
well after the event but does not explain the implications of
these for the fiscal rules.
4. Given the Treasury's past forecasting
record[4]
it is obvious that there is a significant risk of even their calculations
showing the rule being broken. Precise estimates of the probability
depend on the assumptions one makes about whether forecast errors
are likely to persist from one year to the next or not. Nevertheless
it is perfectly possible for the Treasury to estimate the probability
of failure; two years ago this Committee asked it to produce a
fan-chart which would answer the question. The fundamental issue
over the budget projections remains not whether they are right
or not; indeed such a question about a forecast is pointless.
Rather it is that there should be a coherent and transparent statement
of the chance of the Golden Rule being broken and an analysis
of the policy changes which would be adopted if this probability
rose over some threshold.
5. More generally, the debate about the
Golden Rule suggests that it is not a sensible way of targeting
fiscal policy. There are a number of problems
(a) It is not symmetrical. A better arrangement
would be to have a target with a zone on each side of it regarded
as a perfectly satisfactory outcome. We already have this arrangement
with the inflation target.
(b) Estimates of the state of the cycle are
uncertain and subject to substantial revision for several years
after the apparent end of the cycle. Thus the rule cannot be used
satisfactorily in real time.
(c) As noted above, forecasts of public current
account borrowing are inherently uncertain and the fiscal framework
needs to reflect this uncertainty.
6. A more satisfactory arrangement would
probably refer to balance over the medium term rather than the
cycle. But because it is never possible to be absolutely certain
that a deficit is cyclical rather than structural, the Chancellor
would need to make some effort to correct a deficit whenever it
appeared. He would also need to pay attention to the stock of
public debt and monitor how this was changing over and above any
borrowing needed to pay for investment.
7. There is the separate and rather important
question what that medium target should be. A case can be made
that it should be slacker than the Golden Rule target. Since inflation
erodes the stock of national debt there seems to be little wrong
with allowing a medium term level of public borrowing designed
to maintain the stock of debt roughly constant in real terms.
This would allow a steady state current account deficit of up
to 0.8% of GDP.
8. However an opposite argument can also
be made. The United Kingdom is a country with a structurally low
level of saving; the pension crisis is largely the result of this.
In such circumstances there are good arguments to say that in
normal circumstances the Government should run a current budget
surplus. In essence the public sector should save to provide the
retirement benefits which people do not save up to provide for
themselves.
B. Savings Adequacy
9. The main economic issue the country faces
is the question of savings adequacy. This can be explored at both
micro-economic and macro-economic issues. At a macro-economic
level it is anomalous that, although both the Pre-Budget Report
and the Budget Statement are wide-ranging documents they
make no reference at all to the question whether the overall level
of saving in the country is adequate. The United Kingdom has one
of the lowest savings rates in the OECD, the fundamental cause
of the pensions crisis. Turkey, Portugal and the United States
save less.
10. Instead of discussing whether saving
is adequate or not the Pre-Budget Report asserts that "Traditional
measures of aggregate saving . . . often fail to reflect . . .
the positive impact asset growth has had on households' balance
sheets in recent years (paragraph 5.32)". This equation of
saving and capital gains is correct only in very unusual circumstances.[5]
Much more commonly increases in asset prices are ways of enhancing
the position of current generations (or at least those who own
the appreciating assets) at the expense of their descendents.
Thus they function in much the same way as government borrowing.
11. For the country's wealth to grow in
line with its income, without relying on capital gains transferring
resources from the future, the rate of national saving would need
to be over £50 billion higher than it currently is.
12. Even if one takes the view that land
and house prices should be expected to increase in line with wages,
this a substantial savings gap remains. The gap is augmented because
these figures do not take account of the fact that the population
is ageing.
13. The Pre-Budget Report discusses
the implications of low investment on Britain's productivity.
An increase in investment without any increase in saving would
lead to a larger and possibly problematic external deficit. Thus
the questions of investment and savings adequacy need to be considered
side by side.
December 2004
4 Over the last couple of years they have been slower
than some independent forecasters to recognize the true state
of the public finances. The National Institute publishes a budget
fan-chart indicating the error margin round budget forecasts.
The implications of the Treasury forecasting errors were discussed
by me in The Guardian on 14 November 2003. There I argued
that the chance of meeting the target with the cycle ending in
2005 was just over 50%, so it is no great surprise that the current
projections show it not being met. Back
5
For example if the price of capital increases because existing
capital becomes more productive. Back
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