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I shall start by discussing the macro-economic stance. Each week that goes by, the economic news seems to become worse. The speed at which this country, like every other major developed country, is entering recession seems to be gathering pace, whether we are talking about the rapid and significant increase in our unemployment, the dramatic fall in inflation and commodity prices or the further downturn in net mortgage lending, which we heard about yesterday. It is becoming widely accepted that our global financial system has experienced its most severe instability since the first world war. The Opposition would be right to suggest
that monetary policy should take the strain if this were a typical downturna downturn generated by a failure of domestic economic policy or a downturn in domestic demandwith fiscal policy taking a subordinate but supportive role, but this is not a typical economic downturn.
Mr. Andrew Pelling (Croydon, Central) (Ind): The right hon. Lady recognises the robust way in which the Government have acted, but surely it is not enough just to have rescued the banks; it is necessary to repair them too. In reality, they are not in a position to lend until those bad debts are taken off their balance sheets, and a bad bank needs to be created to do that. Time needs to be taken to create a new bankperhaps a post bankthat would be able to lend effectively in the economy and get economic growth going again.
Ruth Kelly: I intend to discuss how to try to get banks lending to each other again in due course. Creating a bad bank to deal with toxic assets is not necessarily the right way forward, partly because it is incredibly difficult to value those assets appropriately and the Government end up taking all the very worst of the debt without appreciating its true value. Of course, everything ought to remain an option as we go through these difficult times.
The Opposition have failed to appreciate a fact that was the essential point of my right hon. Friend the Chancellors statement. In a global credit crunch the impact of monetary policy is at best uncertain and at worst negligible. Evidence mounts day by day, week by week, and even though the 1.5 per cent. interest rate cut was passed on to people with tracker mortgages, credit conditions remain incredibly tight. That is the case for mortgage holders but more particularly for small and medium-sized enterprises. There is evidence that good going concerns are being refused credit, that the availability of credit is shrinking and that the price of terms that have already been agreed has also increased.
Although the 1.5 per cent. cut has been passed on to those with tracker mortgages, the spread between inter-bank lending rates and base rates remains stubbornly high and there is no immediate sign that it will be reduced. In such circumstances, it would be hugely unwise to rely on monetary policy as the way out of the recession. Of course, monetary policy might help somewhat and if there are further deep cuts in interest rates they might act as a stimulus, but we should not bank on those measures as the only stimulus.
In precisely such credit constraint conditions, fiscal policy becomes ever more potent. I am glad that the Opposition have at least come to realise the importance of using the automatic stabilisersa term that is now entering common currencyas tax receipts fall during a recession and benefit payments rise. It is incredibly important that the automatic stabilisers are used not to provide a fiscal stimulusthey do not do sobut to prevent fiscal policy from tightening and exacerbating any potential recession.
All credible economic commentators around the world seem to concur that a fiscal stimulus is needed, rather than just a use of the automatic stabilisers. In fact, the Bank of England, which published its quarterly inflation report yesterday, assumed as its central prediction that output would start to pick up from the middle of next
year. The Bank of England, far from making the Governments case look somehow out-of-step and over-optimistic, also expects growth to resume from the middle of next year. However, it did not take into account the potential impact of any fiscal stimulus. The report states that
the slowdown may be less pronounced if...there is a stronger stimulus from fiscal policy.
It is not just the Bank of England. The Institute for Fiscal Studies welcomed the fiscal stimulus this morning, as did the CBI. Abroad, we are backed in our resolution by the IMF and by most credible economists and commentators. The argument against the use of fiscal policy usually rests on the following facts. First, people think that it takes too long to implement and if not carefully designed can end up turning a fledgling recovery into an unsustainable boom. Secondly, some people argue that if taxes are cut in the short term people will not necessarily spend the extra money because they think that taxes will rise in the medium term. Thirdly, people think that a fiscal boost could add to inflationary pressure. The likelihood of inflationary pressure being a problem seems entirely remote and should not keep many people awake at night.
Let me turn to the first two potential problems. Will the cut in VAT and bringing forward spending take too long to implement? Absolutely not. As we know, the cut in VAT has been turned on to take effect almost immediately and is clearly temporary, so VAT will rise in the future. The beauty of the VAT reduction is that unlike direct income tax cuts it can be implemented virtually straight away and can clearly be seen to be temporary. Given the potential severity of the downturn, it does not seem at all plausible that the measure could end up stoking a domestically generated boom. I find it extraordinary, incidentally, that the Liberal Democrats are arguing that a permanent funded tax cut could ever act as a temporary fiscal stimulus, but I leave that to their spokesman to explain in the future.
Is it the case, as the Opposition sometimes seem to argue, that people would just pocket the reduction in taxes and not spend the money to produce the desired stimulus? I find that hard to believe given that households across the income spectrum are credit constrained. That is what is happening with the global credit crunch. When people have more money in their pockets to spend, they tend to spend it. The Government have made a fairly conservative estimate, saying that about half will be spent and half will be saved. However, even if half that money is saved it will be because people are paying back their debts, and that will place them in a stronger position to spend in the future.
The Government forecast that the reduction in the impact of the recession will be about half a percentage point. It is easy to underestimate that effect. That reduction will keep a much larger number of people in their jobs throughout this downturn than would otherwise have been the case. It will keep more small businesses afloat, many of which would have gone bust during the economic downturn.
Of course, all that is likely to be far more powerful if countries act together rather than independently. When people spend their money on fiscal boosts, some of it will clearly go on imports from other countries. If
everybody acts together, the impact of a fiscal stimulus is likely to be far more powerful. For that reason, we should welcome the fact that Japan, Germany, Spain, South Korea and China have announced or are planning a significant stimulus package. In particular, we should welcome the move announced yesterday by the United States. The injection of $800 billion into the US economy should have a pronounced effect not just on them but on us.
What happens to the public finances over the medium term is obviously important when it comes to the UKs position. I noted that the hon. Member for Tatton (Mr. Osborne) talked about the seven-year figures as fantasy figures. I cannot agree with that. What is the alternative? When a global credit crunch causes permanent deterioration in and damage to the output of the economy and when one cannot foresee how quickly corporate profitability will increase in the futureit will clearly remain low in the medium termit is right that we should take our time before public finances are brought back to balance. The alternative, which would be to bring them back to balance much more quickly, would risk tightening fiscal policy at a time when another shock might come along in the system and make it worse.
Mr. Geoffrey Robinson (Coventry, North-West) (Lab): On the question of receipts that probably will not come backthey certainly will not do so in the near futurein financial services, such activity represents one third of the total receipts of the sector, which will probably not come back at all. Does my right hon. Friend agree that that represents a structural problem for us to overcome?
Ruth Kelly: It does. As my hon. Friend knows, that would mean that whatever the Government decided to do as a fiscal stimulus, either spending would have to be restrained or taxes would have to go up in the future. Given that we can use the fiscal stimulus, it is likely that we will pay back less in the future by ensuring that the economy does not suffer some of the permanent damage that might otherwise be inflicted.
Paul Farrelly (Newcastle-under-Lyme) (Lab): I appreciate my right hon. Friends points on monetary policy, particularly if those people who have access to the best trackers also racked up the biggest credit card bills in good times and therefore pass the reduction down by paying the debts. In that instance, in uncertain times, monetary policy has a limited effect. With respect to fiscal policy and Government spending and actions, does my right hon. Friend agree that it is important that the levers that we pull work? For instance, social landlords should build social housing.
That brings me on to inter-bank lending. As my right hon. Friend the Chairman of the Treasury Committee has pointed out so forcefully, there is a risk that what is right for any single bank in isolation is not right for the banking system. I urge the Chancellor to consider very seriously the proposals laid out in the Crosby report yesterday.
Any proposal, whether it is for a new state institution or is a Crosby proposal, will have to pass some fundamental tests. Do we really want the market in mortgage-backed securities to be resurrected at a time when the mortgage-backed security market has dried up? Would it potentially bias one form of lending against another? How does it fit with the credit guarantee schemes and will it make them more likely to work, or will it crowd out those proposals?
We should act together to try to get the banks to start lending to each other. We are in serious times that demand serious solutions. I urge my right hon. Friend the Chancellor to take any action that he thinks is appropriate.
Mr. Kenneth Clarke (Rushcliffe) (Con): I am afraid that in this country we are probably facing the longest and deepest recession of my lifetime. I entirely share the sentiments of my hon. Friend the Member for South Staffordshire (Sir Patrick Cormack); I hope that my forecast, along with all the other more gloomy forecasts, is wrong, because I do not wish to see the levels of unemployment, housing repossessions and business failures that we will see if we do indeed have the worst recession since the second world war. It is a very real risk, however, and there is no doubt that the global financial and banking crisis is the worst of its kind for at least 80 years. It has been made worse in this country, and we are more exposed than most developed countries, largely because of the mismanagement of the public finances and the failure to retain a sufficiency by way of firepower in the public finances. That is largely down to the former Chancellorthe present Prime Ministerand the complete failure of the regulatory system that he put in place when he took office.
Mr. MacNeil: Prior to the 2007 election in Scotland, which Labour lost, Labour people ran around with scare stories about how there would be £5,000 of debt per household in Scotland. The Governments own figures for the end of that period show a figure of £48,000 in debt per household. Does the right hon. and learned Gentleman think that the Chancellor and the Government should apologise?
I am not going to go back to past recessions, although the Government always refer to the two that we had previously, which we shared to a certain extent with the rest of the globe and which, I remind them, we successfully exited. Obviously we looked at the usual monetary and fiscal weapons; indeed, we used them in a new way. We used monetary policy to target inflation, because they were inflationary recessions, and we went for sound fiscal policy to restore confidence in the public finances and provide the background of stability that was required to get back to growth in the economy. Of course we looked at all the options, including fiscal stimulus. However, I remind the House of my right hon. Friend Lord Howes Budget in 1981. When he imposed very stiff increases in taxation and reductions in public spending in order to get back to fiscal stability, he was berated by all the so-called Keynesiansit was a bit of an insult to
John Maynard Keynesfor doing so, but it was successful. I will not dilate on my own Budget of 1993, but I also had a fiscal problem, to a modest extentit was not as bad as the one faced by Geoffrey Howeand I did the same thing. Fiscal stimulus can be considered, but there are often good reasons for rejecting it.
Sir Peter Tapsell: As someone who berated the 1981 Budget well before the 364 signatories to the famous letter, I said that a Budget that I described as intellectually and economically illiterate would destroy the base of British industry, and that was truethe west midlands has never recovered. The 1981 Budget is the reason why now, with the collapse of our financial industry, we do not have a proper industrial base.
Mr. Clarke: My hon. Friend was the most distinguished of those very strong critics in 1981. I did not agree with him then, and I do not now. I agree that our industrial base was destroyed, but I put that down to the excessive strength of sterling before 1981, which destroyed our competitive position. However, we can debate that hereafter.
Fiscal stimulus was not used on either of those occasions, and we successfully recovered from a recessionand the current Government benefited from that. The long track of figures that the Chancellor recited today were part of the process of getting the level of public debt back under control and getting the budget surplus steadily reduced so that the new Government could merely say that they would stick to the Major Governments figures. They then found that they were restored to balance in fairly rapid order; indeed, they began to accumulate very large Budget surpluses once we had the dotcom boom.
This crisis is differentit is at heart a banking and a credit crisis. I agree with the several speakers who have said in interventions or speeches that that is the main point that we must keep our eye on. Unless and until we get back to the normal functioning of the banking system, we will not have restored the British economy to health. Although it is very important to debate the public finances and the tax and spending proposals, as we are today, because they are part of the picture, to some extent we are addressing a symptom, not the root cause.
I want to emphasise that the big gap in Government policy, which was not really referred to in the PBR and was only hinted at by the Chancellor in his speech, is that they still have not produced a credible package to get the banking system functioning properly againby which I mean resuming lending on a sound and commercial basis to households and businesses that can properly afford to take on the debt under a proper system of risk
management. We are a million miles from that at the moment, and for as long as we remain so we will not have recovery; indeed, we are only at the beginning of recession that will almost certainly worsen well into 2009.
Of course we all agree that monetary policy should be used as far as it can be. We are now in a position where the further reduction of bank rates is inevitable. I think that the Bank of England is the one institution that has handled itself pretty well, both before and during this crisis. I exclude it from most of the blame for the catastrophic folly that led up to the beginnings of the current problems. The trouble nowI actually agree with the right hon. Member for Bolton, West (Ruth Kelly) on thisis that monetary policy, in its classic sense, is not working and will not work for some time. The levers are not connected to the system. The availability of credit and the price that one has to pay for it does not bear much relation to the Bank of Englands base rate. At some point that will click into gear again, but it could be some way off, so we have to look to fiscal policy.
My views have been quite well reported. Of course I accept that in these circumstances anybody will consider the prospects for fiscal stimulus. It is important, across the globe, that the surplus countries go in for very substantial fiscal stimulus. However, everybody has to consider whether the pressing problems of the forthcoming recession justify a degree of risk, and they do justify a degree of risk if fiscal stimulus will work. The key judgment is whether the state of the public finances makes the risk totally unacceptable.
I agree with the hon. Member for Twickenham (Dr. Cable) that there needs to be a balance, but it is a key judgment call. He seems instinctively to rush in saying, Regardless of the quite appalling state of affairs that is revealed in the pre-Budget report, we still have to add another £20 billion to what is already there. I come to the opposite conclusion. We only have to begin at last to get some up-to-date figures, and to see what is revealed, on a very optimistic basis, in the pre-Budget report, to realise that another £20 billion is not available for fiscal stimulus. I thought that that was where the Liberals stood. Only a fortnight ago, we had an exchange in the previous debate where the hon. Gentleman ruled out fiscal stimulus.
Mr. Clarke: Well, I tackled the hon. Gentleman on his tax proposals, and they were redistributive tax proposals whereby the rich were going to pay for tax cuts for the poor. I think that, rather like in the case of the Government, that is more electoral than economic in its objectives; that is debatable. In any event, he ruled out fiscal stimulus and has suddenly become a convert to it.
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