Examination of Witnesses (Questions 40-59)
MR ROBERT
CHOTE, PROFESSOR
DAVID MILES,
MS BRIDGET
ROSEWELL AND
DR MARTIN
WEALE
17 MARCH 2008
Q40 Mr Brady: Is that a consensus
view or is there anybody who would have liked to have seen fiscal
policy used more actively?
Mr Chote: I think one of the difficulties
with the way the current framework is set up is that at the moment,
with having the Bank of England given an inflation target, it
is the Bank of England that is the second mover and essentially
decides how much aggregate spending it is safe to have in the
economy. If you were to do something much more expansionary on
fiscal policy and the Bank thought that was over-egging it, the
sort of discussions we have had before, then they would offset
that, and similarly if they went in the other direction. In a
sense, the Treasury is only able to affect the policy mix. The
Bank of England decides how much overall expansion or contraction
is appropriate and, as you discussed earlier, at the moment they
are caught between the desire to shallow out the downturn and
at the same time not wishing to see the short-term inflation boost
get into wage settlements. So I think there is a broader issue,
about the way in which responsibilities are given, leaving aside
the fiscal rules.
Q41 Mr Brady: Are there places that
you could have targeted fiscal changes that would have avoided
that policy response from the Bank of England?
Dr Weale: The solution is to have
joint policy setting and not to have an independent Bank of England
but to manage monetary and fiscal policy jointly. Independence
has worked much better certainly than I had expected when it was
introduced ten years ago but, at the same time, there may be some
circumstances, and perhaps we are seeing that now, when co-operation
rather than independence is more suitable.
Mr Chote: You would certainly
hope that we would have discussions going on, say, in the run-up
to a Budget in which the Treasury came to the Monetary Policy
Committee, or at least some subset of the Monetary Policy Committee,
and said, "These are the things which we believe may be necessary
for the medium-term health of the public finances. Is that going
to make your life more or less difficult or no difference at all?"
They at least need to understand how the other party will react
to decisions even if there is not a formal getting together and
coming up with a joint view.
Q42 Mr Brady: Can I move on to the
question of the Government's forecast and in particular the Government
has had to move its forecast back a year for when it believes
the Budget will be coming back into surplus. How likely is it
to beat that forecast?
Mr Chote: This is pretty much
the seventh budget running in which the Treasury has said that
things are not going to improve quite as quickly as they had thought
and the day at which one arrives in the Promised Land always seems
to be that one year further away every year. The Treasury has
effectively admitted to about a £7.5 billion permanent deterioration
in the outlook for the public finances which clearly reflects
in large part the movements in equity prices since the Pre-Budget
Report, expectations that were described as "sluggish or
flat house price growth", associated conditions in the property
market, consumer spending being weak relative to GDP overall,
and more consumer spending going on things on which less VAT is
paid. Confronted with that £7.5 billion gap they have essentially
said, "We are going to raise £2.5 billion of taxes looking
five years out" and they have also tightened the assumed
spending squeeze in Spending Review 2009 and are borrowing a bit
more. So they have dealt with some of it by measures, some of
it by assumption and some of it just by borrowing more. History
suggests—to bring back uncertainty—there are very
big variations either side of the likely path but so far it has
been seven budgets running in which the errors have been in the
same direction.
Q43 Mr Brady: Just looking at the
question of inflation and its effects on the public finances,
obviously inflation affects tax receipts but also makes it harder
to meet spending obligations if there are fixed plans. On balance,
is higher than expected inflation beneficial or detrimental to
the Government's fiscal position?
Mr Chote: I do not think that
comes out easily from this. It depends partly on how you respond
in terms of the spending. If you are holding to the cash spending
numbers then that is giving you some element of constraint. It
looks as though the Treasury has pushed up its spending forecast
reflecting the impact of higher inflation on higher benefit and
tax credit costs so, therefore, you are getting a smaller cut
in spending as a share of national income over Comprehensive Spending
Review 2007 than they had originally intended, which I think is
part of the reason why they are not putting in this even tighter
squeeze in Spending Review 2009 to make the numbers all stack
up.
Q44 Mr Dunne: A couple of questions
about the sustainable investment rule that you have just touched
on with Mr Brady. Given the poor forecasting record that the Government
has for its own debt, how credible is it that it will achieve
the sustainable investment rule in the forecast period?
Ms Rosewell: On what definition?
Dr Weale: 50/50 on their forecast.
Mr Chote: Exactly, 50/50 on their
forecast assuming that the chances of them being overly optimistic
and overly pessimistic are in line with the long run average rather
than the recent years in which it has all been in one direction.
The headroom below the sustainable investment rule is now £2.8
billion, that is a couple of years out, and the average forecasting
error for the budget deficit one year ahead is about £13-14
billion, so 50/50 would seem a pretty good stab at it.
Q45 Mr Dunne: That all excludes Northern
Rock?
Mr Chote: Yes, because Northern
Rock effectively has added 7% of GDP so you are through it already
on that definition.
Ms Rosewell: Or the treatment
of PFIs for that matter.
Q46 Mr Dunne: Indeed. If you take
Northern Rock first, do you think the Government's approach to
excluding Northern Rock from the public finances for the purposes
of their fiscal rules or the sustainable investment rule adds
credibility or retracts credibility from the rules?
Dr Weale: I must say what I would
have done is to say the 40% is a target, the nature of the world
is that things happen that you do not expect and we have exceeded
the target, but on this occasion we think we do not need to do
anything about it because crossing the target has come about because
we have taken over Northern Rock and unless it appears that the
taxpayer is going to suffer financial loss as a consequence we
can simply wait for Northern Rock to be taken off the balance
sheet again. Presentationally it has been very bad but the conclusion
that they have come to is correct.
Q47 Mr Dunne: Is that view shared,
Bridget?
Ms Rosewell: Yes.
Q48 Mr Dunne: In relation to the
IFRS changes, those have been put off a year and when they get
taken into account in the public finances is that the time to
rewrite the rules do you believe?
Mr Chote: There you are not seeing
something that you can say is a temporary factor. You have taken
evidence on this recently and I do not know whether you were given
a firm indication of what the likely magnitude is going to be,
but it seems hard to imagine that this is not going to have an
impact greater than £2.8 billion.
Q49 Mr Dunne: More like 10-fold 2.8
billion.
Mr Chote: The maximum you end
up with is something like £30 billion if everything goes
on that is currently off. I am not clear what proportion of that
that would be. The 40% target was always an arbitrary number to
start with. The difficulty, of course, was that when the Treasury
embarked on this years ago they thought they would be so far away
from it, at worst, that you could have these sorts of definitional
changes, which do take place from time to time, and that would
not have been an issue. But, of course, as the room for manoeuvre
has been progressively removed, you are now very close. So either
some definitional change like this or, indeed, some mildly weaker
outlook for the economy or suddenly deciding that yet again the
one-off winter fuel allowance is not going to be one-off puts
you in that sort of difficulty. This is coming back to the point
Martin made earlier on, that at the moment the Treasury is still
sticking with this: "We are below 40%, what is the issue?"
There is no discussion of, "If for a variety of reasons that
might not be the case, what is the sensible approach? Are we going
to change the rules? Do we think we have breached this, but we
just explain the circumstances". The worst thing you can
do is basically say, "There is no problem. There is no problem.
There is no problem" and then just move the goalposts at
exactly the point at which you would cross it, which was what
happened with the Golden Rule and it looks like they are setting
themselves up for exactly the same thing with the sustainable
investment rule.
Q50 Chairman: Given the problems
that the Government had in defining when the economic cycle ends,
how useful is the Golden Rule?
Mr Chote: There is no harm in
saying again that this approach of identifying a fixed end to
the cycle seems to be ever more absurd with every passing year.
I would point you to the entertaining chart on page 154 where
the Treasury has concluded that after the current negative output
gap—the little downturn we are having at the moment—growth
is only fractionally above trend and therefore it takes four years
in order to get the output gap back to zero. There may be a modelling
approach which explains now why they believe that this output
gap is going to be closed very, very gradually over this period.
Cynics, if there are any among you, may say the advantage of having
a long attenuated recovery like that until you close the cycle
is that it gives you more years of fiscal drag to get the underlying
position to improve and, surprise, surprise, if you have either
a six year cycle or you bolt six years on to the previous definition
of the cycle, surprisingly enough we happen to meet the Golden
Rule on both those timescales.
Dr Weale: Could I say that the
Golden Rule should be replaced by a prospective rule about the
state of the public finances in the medium term and because there
is uncertainty about the future it should be done by an independent
assessment, perhaps by Parliament and this Committee.
Chairman: We have mentioned this ourselves
in the past. I wanted to ask that question to see if your minds
were still alert!
Q51 Mr Mudie: Robert, if we are that
close in the definition of change that might push us over there
is obviously a political argument against phasing public expenditure
differently, but is there an economic argument against doing that?
Mr Chote: Do you mean against
the argument for reducing spending in the out years?
Q52 Mr Mudie: Yes. If you are that
close and the circumstances are almost unique, if the Chancellor
went to the spending departments and said, "I am going to
re-phase some of your stuff"—
Ms Rosewell: That would only be
the case if you really thought this limit meant something less
than an arbitrary number.
Q53 Mr Mudie: Politically that is
an answer but I am—
Ms Rosewell: Economically it might
give us an arbitrary number.
Q54 Mr Mudie: Is there an economic
case for spending this money at the moment rather than a political
or even social case?
Dr Weale: Economists tend to assume
that people like their consumption, not only spending out of our
own pockets but also the services that are provided to them by
the Government, to evolve fairly smoothly so that we do not get
large step changes, cuts one year followed by increases the next
year. The economic argument is then that supply should be smoothed
out as much as can be done.
Chairman: Thank you very much for that.
We will go on to the next session.
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