Examination of Witnesses (Questions 80-99)
21 MARCH 2005
MR JON
CUNLIFFE, MR
DAVE RAMSDEN,
MR TONY
ORHNIAL, MS
SARAH MULLEN
AND MR
JOHN KINGMAN
Q80 Chairman: Okay. What a lovely way
to say no. Some commentators complain about the scale of the deterioration
in the UK's fiscal position since 1999, suggesting that it has
been "bigger than that of any G7 country, other than the
US". By how much has the fiscal stimulus which has been delivered
over the past few years contributed to UK growth?
Mr Cunliffe: I think I would say
it has contributed quite a considerable amount. I think starting
points matter and we went into the downturn of economic activity
led by the world downturn in 1999-2000 with a very strong position
because in the years 1997-2000 we had tightened fiscal policy
by 4 percentage points. Having gone into that period of downturn
and slower growth with a strong fiscal position, having tightened
fiscal policy in the upturn, we were able to have fiscal policy
support monetary policy in 2000, 2001 and 2002. It is always difficult
to be precise about these things but if you look at what happened
in some other countries that suffered the same downturn, the fact
that we were able to have fiscal policy support monetary policy
during that period contributed a lot to ensuring that the UK experienced
no quarter of negative growth and in terms of the impact on the
economy we have come out of that downturn relatively unscathed.
Q81 Mr Beard: In the Budget you sound
notably more confident about the global outlook than you seemed
to in the Pre-Budget Report saying that risks have diminished
because of increasing evidence that high oil prices reflect strong
demand. Even so, oil prices hit a new high last week and there
are growing market fears that the limited production capacity
could leave the market highly vulnerable to disruption. Is not
any large surge in oil prices, whatever the cause, going to be
destabilising to the international position?
Mr Cunliffe: Clearly if you had
a very large surge that happened very suddenly, if you had a break
in supply, some incident that knocked out some of the world supply,
that sort of risk, yes. I think the point we were trying to make
was when the oil price is high because the world economy is growing
very strongly and demanding a lot of oil, a higher price will
knock down some of that demand but it is the strong oil demand
that is causing the higher price. When you get the sort of oil-related
problems we have had in the past where the higher price has been
driven by the supply side, it has knocked demand down when demand
was weak. We were not trying to be complacent in that assessment
of global risks, the point was simply that we have lived with
those higher oil prices going up and down—oil prices being
quite volatile—for just a little over a year and it has
not caused the sorts of problems that we had seen in the past.
The judgment was that this was more of a problem on the demand
side; energy intensity had gone down in the developed OECD economies:
and even in the emerging market economies, where you would expect
to see a bigger effect that there has been, a bigger impact because
their energy intensity is higher, they use more energy per unit
of output, their debt positions and their foreign currency reserves
have been strong and they have not suffered quite as much as you
would have thought. It was really looking at what had happened
over the last year that made us review the risk of prices remaining
where they are now. With supply being tight, slight or relatively
small problems like a hurricane which take out a little bit of
supply for a while, or some problem in Nigeria, will cause the
price to spike—we will probably encounter more of that—but
the world economy seems quite robust by the evidence of the last
year.
Q82 Mr Beard: After the Pre-Budget Review
you told us that the received wisdom was that when a trade deficit
gets above about 5% of GNP it has to correct. But on Budget Day
the US announced record current account deficit for 2004 of 5.7%
of GNP. Is enough being done internationally to ensure the necessary
corrections are being made in an orderly way?
Mr Cunliffe: The 5% figure is
based on IMF research which was done on what had happened in the
past. I suppose they tried to look at the levels at which that
correction took place. Alan Greenspan would say that the world
has changed; the international savings market has become deeper,
has become more liquid; it is easier for deficits to be financed.
Nonetheless, I think the US current account deficit heading or
increasing past 5% is a concern. I think internationally a lot
has been done with the US in explaining to them other people's
perceptions of the problem—although, I have to say it is
a perception they share. Greenspan has said that it is too high
and it needs to come down over time and I think the US Government
have said the same thing. So it is not as if this is a perception
they are resisting; I think it is a perception they share. They
also share the view in part that some of the problem is not on
the current account but on the capital account side, that there
is not enough saving going on in the US and that therefore over
time they need to address that problem, in particular through
correcting their budget deficit. So I think there is some US recognition
of the issue.
Q83 Mr Beard: In what way does the recognition
amount to doing something about it? How far can this go on before
this becomes the chief threat to international stability?
Mr Cunliffe: I think personally
that the most likely outcome is still that this corrects over
time.
Q84 Mr Beard: Corrects, but with what
consequences?
Mr Cunliffe: As with all imbalances,
if it corrects slowly, then the US economy is able to adjust and
the economies on the other side of the imbalance are able to adjust.
There is a chance—I think it is a minority chance—that
you get a very sharp correction and it all happens at once and
then currencies are affected and economies all around the world
are affected. But I personally think that the majority chance
is that the Americans are taking some action; it is starting to
happen. The evidence I would give for that is if you look at what
has happened to the dollar over the last 18 months, it has come
down a long way. That has caused difficulties for some economies:
it has caused difficulties for Europe; in Asia a number of countries
have tried to maintain the value of their currency against the
dollar and that has caused them to build up big dollar reserves.
But we have had a very big fall in the dollar without instability.
The markets have managed to accommodate it. There has not been
a run on the dollar. It has not hit world growth in a material
way. World growth is 5% for 2004, which is the highest in 25-30
years. We have managed to have a big change in the value of the
dollar—which is part of the deficit—without causing
abrupt changes in economies. I think the likelihood is that that
will continue. In the US there were some signs until very recently
that their exports were starting to come back. Generally speaking,
when your currency depreciates your exports do come back, but
it takes some time. There were some signs—although recent
evidence is much more mixed—that there was some cooling
off on the import side. But some of the correction has taken place
on the currency side and it has taken place without huge instability.
I do not think it is unreasonable to think that that might continue.
Q85 Mr Beard: The IMF recently described
the possibility of a sharper than expected drop in house prices
as "perhaps the greatest near-term risk to the outlook"—this
is to the UK economy. Do you agree with that?
Mr Cunliffe: There clearly is
a risk to the housing market both ways.
Q86 Mr Beard: What do you mean by both
ways?
Mr Cunliffe: House prices have
stopped growing at the very high rates—the 5% a month, 30%
a year that they were at a couple of years back, at the peak.
I think they are now flat. It depends whether you take the Halifax
or the Nationwide—there are lots of different measures—but
the overall picture seems to be that house prices are pretty flat.
One school of thought is that they stay flat. One is that there
is a downside risk, which is what the IMF mentioned, and you get
an abrupt fall in house prices. But I think there is also a risk
that they could start to move up again. The housing market is
quite a difficult thing to estimate. I think I would agree with
the IMF in part. If we had a very sudden movement in house prices,
of the sort we have seen in the past, would there be a risk to
the economy? It probably would not be as big a risk as it has
been in the past, because one thing we have seen over the last
house-price cycle is that the link between house price increases
and consumer spending is nowhere near as strong as it was in the
past. The Bank of England have published material on this. That
relationship between consumer spending, mortgages, equity withdrawal,
house prices that drove a lot of the UK cycles in the past, no
longer seems as strong. Whether if you had a sharp fall in house
prices it would impact on consumption in the way it had in the
past, I think is a very open question. Personally I do not think
it would. There must come a point at which a reduction in house
prices impacts on the economy. I suppose the IMF quotation used
is relative: Is it the largest single risk? I would say it is
a risk. It is a risk both ways: on the upside and the downside.
Q87 Mr Beard: They are not mincing words.
They say, "it is the greatest near-term risk."
Mr Cunliffe: It may be one of
the most important single risks, but I am not sure I would have
described it in quite the same way.
Q88 Mr Beard: The press have suggested
that your projection for a decline in the house price/earnings
ratio implies that you are forecasting a small fall in house prices
in the future. Is that correct?
Mr Cunliffe: I am grateful to
you for using the word "projection" because that is
what it is. We do not forecast house prices; we do not forecast
earnings. Our forecast is a formal document and a formal output
which is the basis of the Budget and the PBR. We do it twice a
year. The projection that we published shows the house price/earnings
ratio going down, but of course there are two ends to every ratio
and that could easily be as much to do with house prices not growing
as quickly as earnings rather than house prices falling. I saw
something in one of the papers last week on this which looked
to me to suggest quite a low earnings growth figure, but, without
knowing how they worked out from our ratio what would happen to
house prices, I do not know. I assume they must have used quite
a low earnings figure.
Q89 Mr Beard: Kate Barker, who has gone
into the housing position in some depth, says, "Simply put,
a change which increases demand for housing, such as a beneficial
shift in taxation which reduced the cost of owner-occupation,
would cause a jump in house prices to restore equilibrium in the
market. What did your pre-Budget analysis suggest would be the
impact on prices, in that tier of the market, of the move to cut
stamp duty on houses under £120,000?
Mr Cunliffe: I do not think our
analysis is that that will have a material impact on house prices.
Q90 Mr Beard: It will not have a material
effect?
Mr Cunliffe: It would not have
a large material effect on house prices. I think it is quite hard
to say there is a one-to-one relationship between any change in
the tax structure and what happens to house prices. But also,
as the Barker report a year ago showed, house prices are driven
by a number of things but primarily and fundamentally they are
being driven by an imbalance between supply and demand.
Q91 Mr Beard: That is not what she is
saying. She is saying that if through the changes in stamp duty
the price goes down, more buyers will pour into the market and
house prices will go up.
Mr Cunliffe: Yes, but I guess
the change in stamp duty here would not be one to cause a huge
impact on house prices. The fundamental drivers of the housing
market are, if you like, basic supply and demand and the things
that drive it are more, to my mind, on the supply side. Obviously
if you had a large enough reduction in house prices, as a result
of any change, more people would be attracted. All other things
being equal, more people will be attracted back into the market,
but there are lots of other factors at work.
Q92 Mr Beard: Your analysis suggests
that house prices would go down on this stamp duty change and
stay down.
Mr Cunliffe: That the stamp duty
price would actually drive them down? I do not know that we have
done enormously detailed modelling on the housing market because
it is a very difficult thing to model, but I think our analysis
is that the effect on the housing market will not be strong.
Q93 Mr Beard: If it is not strong, then
it is not going to help first-time buyers, is it?
Mr Cunliffe: It might help first-time
buyers come back into the market without having an effect on house
prices all the way up the housing market.
Q94 Mr Walter: I have a question which
relates to my constituency, which has average earnings 15% below
the national average. I looked at the local papers over the weekend
and I could only find three houses below £120,000. Have you
done any assessment on how many extra buyers would be attracted
into the market as a result of this move?
Mr Cunliffe: I think we have done
some analysis on how many buyers are likely to be affected by
the change. It is quite difficult to work out how many would be
likely to come back into the market. If I could turn to my colleague,
Mr Ramsden.
Mr Ramsden: I am not wanting to
play pass the parcel, but Tony Orhnial may be able to add further.
I think we are looking for 200,000 or 300,000 properties being
taken out of stamp duty, of which a reasonable proportion will
be first-time buyers. There is obviously quite a significant regional
distribution to the incidence of this. I am not sure which region
you live in—
Q95 Mr Walter: The South West.
Mr Ramsden: There may be some
effect there, but from what I recall of the analysis the highest
incidence was some way from London, up in the North, in terms
of the beneficiaries of this change.
Mr Orhnial: Our analysis suggested
about 300,000 transactions would be taken out of stamp duty, and
about one-third of those associated with first-time buyers.
Chairman: As Members of Parliament who
have constituencies beyond the Watford Gap, they will recollect
you saying "somewhere up North".
Q96 Mr Fallon: Could we now turn to public
finances and the state of borrowing. On your analysis you seem
to have about £6 billion spare to meet the Golden Rule if
the cycle ends next year. How does that £6 billion reserve
compare with your average error in forecasting borrowing over
one year?
Mr Cunliffe: It is quite difficult
to try to compare those two things because I am not sure they
are exactly the same.
Q97 Mr Fallon: What is your average error
at forecasting borrowing over one year?
Mr Cunliffe: The average error
of borrowing one year ahead I think is somewhere round about 1%.
Q98 Mr Fallon: Which is how many billion?
Mr Cunliffe: I am sorry, how many
billion on what?
Q99 Mr Fallon: Analysis we have had from
the IFS is that your £6 billion margin is around half the
Treasury error at forecasting.
Mr Cunliffe: If I could just finish
the point I was making, we are actually forecasting the fiscal
revenues and the fiscal position on a case which is not our central
case. So we have already forecast it on cautious assumptions,
the most important one of which is that we do not use our central
economic projection. Over the years people have told us that our
central economic projections are optimistic, unlikely to be met—some
of your witnesses have been quite strong on that—but actually
over the years they have tended to be met. But we have not forecast
the public finances on them, we have forecast the public finances
on a more cautious assumption, which is 0.25% GDP below that.
There are also a number of other cautious assumptions in the forecast.
So to go from an average error which does not take account of
the fact that we already have caution in the picture, is actually
comparing two things which are not quite the same.
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