Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 280 - 299)



  Q280  Chairman: I gather from the announcement in the House and from your comments here, Chancellor, this scheme is a bit flexible yet and maybe it is something the Committee will look at.

  Mr Brown: I hope your Committee will feel able to look at the terms of the understanding between the banks and the Government.

  Q281  Chairman: We may have some ideas.

  Mr Brown: You may have some ideas about how in certain areas the money could be spent. I do assure you that this is a first step to a resolution of what has been an issue which I think all governments have been having to deal with over many years.

  Q282  Damian Green: Chancellor, in the new spirit of consensus which seems to be breaking out this week, let me say that in previous years it is true on forecasting growth many times you have been right and the forecasters have been wrong, and indeed you seldom neglect to point that out to them. On the same basis, do you admit this year on the whole they were right and you were wrong?

  Mr Brown: I do not know if anybody has been right this year, to be honest. I think this has been one of the difficult years. The reason, let us be clear in this spirit of consensus which is not just about what has happened in the past but what has actually happened this year, is that first of all we have had an international shock, there is absolutely no doubt about it; the volatility of the oil prices but also the size of the change in oil prices and the uncertainty which arises from that. Secondly, that has had an effect particularly on European domestic demand and therefore our biggest export area has been affected and there is lower growth of domestic demand particularly in Germany and the Netherlands, which are two of our competitor countries. Then, as I said in the Pre-Budget Report, and I do not think people should forget this, we were dealing also with a domestic issue of inflationary pressure, and throughout the whole of the last year, 2004, we were seeking to deal with the situation particularly through interest rates, where house prices have been rising by about 15% a year for three years, where house prices at their peak were rising by 25%, and we had to cool down both the housing market and consumer demand in the economy. I put it to you that in any other decade when we either had an oil shock or we have had a hit to the housing market in this way, when we have had to cool down the housing market, in each of these situations we have usually in Britain had to deal with this with a recession, in other words the over-heating has been such that it is only cured by interest rates and in some cases they have gone above 10%, but to have both of these together is the difficulty which had to be faced during the course of this year. That is why I think we should say that to have reached the end of the year with inflation likely to be 2%, our inflation target, where in previous years it could be anything above 10%, is a success for the policy of stability. So I think people will look back on this year and say the economy was challenged, and I did say it was a difficult and challenging time, it was a tough time for the economy but that challenge has been met by us being able to deal with the inflationary problem, both domestic and international, and as we move into next year people can be more confident about growth.

  Q283  Damian Green: Thank you. That came quite close to an admission that the Treasury was wrong in its forecasting, which is a historic break-through for transparency in government. Apart from all the reasons you very validly give, the Governor of the Bank of England has said that one of the additional reasons why there was this slow-down which the Treasury failed to forecast was the quite sharp rise, to quote him, of two percentage points in the ratio of taxes to household disposable income. So it was actually tax rises which contributed to the slow-down. Do you accept the Governor's analysis?

  Mr Brown: I actually think the Governor probably, on reflection, would also talk about the rise of interest rates. If interest rates rise four times, it is bound to have an effect on consumer demand, and it is bound to have an effect on the housing market. I do not think anybody should be in any doubt that four rises in interest rates, which actually happened before the General Election—the first time that has happened in 100, 200 years of economic policy—because we made the Bank of England independent, was bound to be the major factor in affecting consumer demand in the economy.

  Q284  Damian Green: Exactly, and that is why the MPC is independent, which everyone welcomes. The point the Governor was making was that apart from the Bank's legitimate role in dampening down inflation through interest rate rises, tax rises were also contributing to the slow-down, and presumably that is not supposed to happen. We are not supposed to set fiscal policy for reasons of old fashioned demand management.

  Mr Brown: I do say that one has to look at all the factors here. If you look at what has actually happened over the last year, wages have been rising slower than we expected. One of the reasons why income tax receipts are less in some areas than we might have thought, and one of the reasons why consumer spending is lower, is not only because we have had the four interest rate rises I have referred to but actual pre-tax wage rises have been lower than expected. So I think you have to take that into account as well. I think those people who are looking for one explanation of what happened during the course of the last year are wrong because there are two separate factors, and in each of them there are particular characteristics of the change which took place. One is the international shock which arose from oil prices and clearly with America having inflation now of 4.3% as a result of the oil rise, they are having to deal with higher interest rates with that inflationary pressure, but equally we were dealing with a domestic challenge and the challenge was house prices rising too fast, consumer spending having to be slowed down. If you ask me what the situation is at the end of the year, in any other decade these two factors coming together would have brought the British economy into recession. In our case, because of the policy which was essentially the pro-active and pre-emptive policy of the Bank of England, we have slowed the economy, but at the same time we have done so avoiding a recession and having inflation now near to target at the end of the year.

  Q285  Damian Green: The panel of economists we had in front of this Committee yesterday, broadly speaking agreed that they were less optimistic looking two or three years out than the forecast in the Pre-Budget Report. Again, you say everyone was wrong this year, but why do you think you are right to be more optimistic than the consensus about what is going to happen later this decade?

  Mr Brown: You quoted the Bank of England only a few minutes ago, the Bank of England's forecast for next year is 2½%, our forecast is less than that, so we are not being over-optimistic about next year, and I do not think people would say that we are being over-optimistic about next year, and I think that is the case. The Bank is 2½%, we are 2.25%, if you take the range.

  Q286  Damian Green: I was thinking further than that, because I think everyone would agree that one of the reasons for growth in recent years has been the rapid growth in public spending, and what we see in this PBR is the nearest we have come to a squeeze. If you look from 2007-08 onwards, the growth of spending is projected to be 1.8% below the trend rate of growth in the economy. Are you planning to share the fruits of growth between public spending and other priorities?

  Mr Brown: The figures that we have put for the period after 2008 are the assumptions that have been in our documents for many years now.

  Q287  Damian Green: But as they come closer clearly they become whole life projections.

  Mr Brown: Hold on. These are not new figures. These are figures that we have used on many occasions before. They were published before the general election; indeed, they were published a year or two before. We have got a spending review in place. It will have to report next summer and we will have a full report in 2007. I think you should wait until you see the final documents as they appear.

  Q288  Damian Green: So we should not take these figures very seriously?

  Mr Brown: What you should take is the figures that we have been working on, not just for this year but for many years.

  Q289  Damian Green: Looking further out again at the long term financing aspects, the long term public finance report, the analysis of fiscal sustainability points out that at the current rate of progress—this is taking 5.1 on page 45—the amount of spending done by the public sector as a percentage of GDP by the middle of this century will rise to 45%. Do you think that will be sustainable?

  Mr Brown: I think you had better look at the assumptions that were made there. These are cautious and prudent in the sense that we are assuming, for example, on pensions something that we have not decided. I wrote to the Chairman of the Pensions Commission, Lord Turner, and said that he could not assume that we would raise pension credit in line with earnings after 2008 simply because we had always put in our figures cautious assumptions about what pensions might cost in the years to 2050, so these figures cannot be taken as either definitive or the figures that would eventually be the right figures. I think you will find a table in that document showing why the pension figure is in a sense the worst case scenario rather than the figure that we expect to be reached. In fact, by our announcement about the pension credit it shows that that figure will not necessarily be the right figure at all.

  Q290  Damian Green: And you would not wish it to be the right figure, I take it, from that answer?

  Mr Brown: The point I am making is that there are a lot of decisions that have to be made about 2008 and then about the spending round after that, and you cannot take that to be the figure, no. It is not the correct figure.

  Q291  Damian Green: And pensions are a significant contributor then? That is one of the problems. You have made the point several times in the past few weeks that Lord Turner should not make that assumption.

  Mr Brown: I think people know the situation. Alan Greenspan is finishing his term as Head of the Federal Reserve by warning America about the cost of pensions over the next period of time. The German and French Governments already spend 10% of their national incomes on pensions. These figures will rise to 15% or 16% by 2050 in these countries and I am determined that we only make decisions that are affordable for the long term. You cannot take the figures that are in that document as anything other than cautious figures, but figures that we do not think are the figures that are the basis on which we will plan our policy for the years ahead.

  Q292  Mr Ruffley: Chancellor, you have got a bit of previous, have you not, on fudging and fiddling figures? I want to ask you some questions about the changes to the length of the economic cycle which, of course, influence whether or not you meet your golden rule on borrowing. You have made two major changes this year, conveniently since the Budget and since the general election. In July you moved the start date of the current economic cycle back two years so you could conveniently include two years of Budget surpluses. Now, this week, you have moved the end of this cycle, the projection, to 2008-09. When my colleague, Mr Fallon, asked this question in July about moving the cycle back two years to 1997, he said, "But the redefinition of the cycle does help you meet the golden rule . . .", and you said, "My view is it would meet the golden rule anyway". That is not true, is it, Chancellor? If you had stuck to the original start and end dates, 1999 to 2005-06 from the independent IFS, you would have broken your golden rule by nearly two and a half billion. That is what Robert Chope tells us.

  Mr Brown: I do not accept any of these figures.

  Q293  Mr Ruffley: Why not?

  Mr Brown: I am going to pass round to the committee—

  Q294  Mr Ruffley: Why not?

  Mr Brown: If I am allowed to pass round to the committee a document that shows what actually happened between 1997 and 1999—

  Q295  Mr Ruffley: That was not the question. If you had kept the economic cycle from 1999-2000 and 2005-06 you would have missed your golden rule. What I am saying to you is that in July you said, "It does not matter. We would meet it anyway". That is not true. You got it wrong, did you not?

  Mr Brown: I am sorry, Mr Ruffley. The facts are that there was no complete cycle between 1997 and 1999. If the facts are that there was no cycle then we cannot allege that there is a cycle now. I am passing round these figures which I would ask the Committee to look at in some detail.

  Q296  Mr Ruffley: I would ask the Committee just to look at the National Audit Office assumptions. Let us get on to this. You raised the issue. They talked about this change in the economic cycle, so it starts in 1997. They used the word "uncertain" throughout the report and I am talking about the NAO report published this Monday by the Comptroller & Auditor General. Let me quote this for you in case you have not read it closely enough. He says, "I recommend that the Treasury considers more systematically than previously what estimates of the output gap would be if other techniques were used", and that, of course, impacts directly on your decision to extend the economic cycle to 2008-09. Is that not true?

  Mr Brown: I would ask you first of all to look at the information I have put to this Committee.

  Q297  Mr Ruffley: I am asking you about what the Comptroller & Auditor General says. I want a response to his question.

  Mr Brown: I would ask the Committee to look at the information I have given them.

  Q298  Mr Ruffley: You are not answering my question.

  Mr Brown: I am answering your question.

  Q299  Mr Ruffley: Could you answer the questions I ask rather than the ones you want to imagine I asked?

  Mr Brown: Paragraph 77, "Though there are many uncertainties, there are reasonable grounds to date the end of the previous economic cycle in 1997". That is what he says.

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