Examination of Witnesses (Question Numbers
14 DECEMBER 2009
Q40 Mr Plaskitt: I want to explore
whether there is a possible trigger for the second dip, as it
were. If QE stops or is reversed and that does prick the bubble
of equity markets and house prices, for example, that would have
a big impact on consumer confidence, would it not? Would you then
be back into a second dip?
Mr Weale: I suspect one reason
why the Treasury is more optimistic than I am about consumer spending
in 2011 and 2012 is that they have built greater buoyancy into
house prices than I anticipate.
Ms Ward: Can I maybe add some
comments on that. I am sorry I am going to disagree again, Martin.
The real economy was in a very unpleasant vicious cycle earlier
in the year and we were looking at the prospect of another Great
Depression. Monetary policy in general and QE globally has contributed
to turning that forecast around and the rise that we have seen
in asset prices merely is pricing out that tail risk. The Governor
made a point last time he was in front of you, and I would really
agree with him, that every time asset prices in financial markets
are going up (perhaps not the housing market; I think there are
some unusual things going on there) we should not call it a boom
and every time they are coming down we should not call it a bust.
There are legitimate reasons for it and theory would suggest that
asset prices should rise every day because they are a nominal
variable. I think it is pricing out that extreme downside risk
and I do not think it is particularly contingent on our quantitative
Professor Dow: One point on quantitative
easing, although the programme is coming to an end, the effect
of the programme is to have placed a lot of liquidity within the
banks so there is a large capacity to lend which is not being
utilised at the moment, and that could finance much more activity
in asset markets or in the real economy.
Q41 Chairman: A large capacity to
lend which is not being utilised; why?
Professor Dow: Presumably because
they are holding back because they are concerned about default
risk among potential borrowers.
Chairman: We thought that. It is just
good to get it on the record. Michael?
Q42 Mr Fallon: Table B.15 shows debt
interest and projects it for next year at £44 billion. It
does not give any figures for the following three years. Can anybody
help me with that?
Ms Ward: I did those calculations
for you this morning, so I can help you.
Q43 Mr Fallon: What are they?
Ms Ward: On my calculations, using
the current market yield curves or the forward curves at the end
of the forecast horizon, in 2013-14 the interest paid on debt
rises to £61 billion, which would take that up to 8.6% of
total current expenditure or 3.5% of GDP.
Q44 Mr Fallon: What are the missing
two figures in the middle then?
Ms Ward: Prior to the crisis it
was about £30 billion.
Q45 Mr Fallon: 44 next year but the
two missing years?
Ms Ward: 51 and 56.
Q46 Mr Fallon: Is there any reason
why those estimates should not be given by the Treasury?
Ms Ward: Not as far as I am aware.
I was able to do it for you quite easily this morning.
Q47 Mr Fallon: Can anybody else help
us there? Have they been published in previous years?
Mr Chote: The debt interest figures
further out? You can have a rough stab at it because the Treasury
publishes a profile for total public sector borrowing and for
the primary balance, which is the borrowing minus net interest
payments, so if you take one away from the other, you have, albeit
at heavy levels of rounding, an estimate of where debt interest
would be. I have got a rate of change rather than a level here.
Our best guess is that over the Spending Review period you have
debt interest rising by just under 11% a year in real terms.
Q48 Mr Fallon: So your figures instead
of 51 and 56 are what?
Mr Chote: I do not have a level.
In terms of decomposing the change in spending over the Spending
Review it is about 11% but I can get those if you want.
Mr Fallon: That would be helpful, thank
Q49 John Thurso: Robert Chote, in
your opening comments when asked what was left out, I think you
said something along the lines of a lack of clarity on spending
on public services. Can I ask you to expand on that? From the
note that you have given us it would seem that current expenditure
is set to grow but there are "deep cuts"your
wordsin investment spending and that by 2013-14 services
overall need to pick up by £36 billion and there is about
a £15 billion gap. Is that the picture you are painting?
Mr Chote: Yes, the picture that
we have in terms of the figures that the Treasury has published,
they have said that current non-investment spending will rise
by 0.8% a year over the next Spending Review, which is fractionally
higher than the rate that they gave at the time of the Budget.
Investment spending is falling by about 19% a year in real terms,
again not hugely different from the figures at the time of the
Budget and therefore leaving total spending roughly flat in real
terms again, not very different from the time of the Budget. In
an ideal world what we would like to do, given that overall set
of spending numbers, is to be able to say how much does the Government
think it is going to have to spend on annually managed expenditure,
which is the things over which it does not think it has a great
deal of control, of which debt interest is one and social security
payments is another. Other AME things like public sector pension
payments will be a third category. That then leaves you with a
picture of what you have to spend in departmental expenditure
limits, which is basically Whitehall spending on public services
and administration. We know the Treasury produces that breakdown,
it was leaked late in the summer, so we discovered what the breakdown
was then and it was showing departmental spending falling by 2.9%
a year in real terms on average over the Spending Review period.
So I am sure you will be asking officials if they were able to
produce those numbers at the time of the Budget presumably they
will produce them now and would they care to share them with you!
As we did after the Budget, we have had a stab at trying to work
out what that is. As I mentioned, we are now estimating debt interest
rises a little less quickly than thought at Budget time but still
about 11%, 10.7% to be precise, and social security costs up 1.5%
a year in real terms over this period. We assume that other AME,
which is a mystery to all that behold it, continues to rise at
the 3.1% put down in the leak. That leaves us with departmental
spending falling on average by 3.2% a year over the three years
of the Spending Review. That is slightly larger than the 2.9%
a year that was in the leaked document. That might be explained
partly by the fact that the Government has put some more money
into the base year for Afghanistan, so the starting point is higher
which means the average decline over that period is greater. If
you then say what is the impact of cutting departmental spending
by 3.2% a year over three years, you are looking at a real cut.
It is about £36 billion by the third year. The Government
has claimed that it has found various savings and ways of cutting
money that will help to meet such a decline, although, as I say,
that is our number and not theirs. For example, the efficiency
savings that were outlined earlier in the week before the PBR,
and if you take those factors you are left with 15 as the residue.
Q50 John Thurso: So the 15 is the
amount that is going to have to be found at some point to deliver
the policy objectives or the numbers that are set out?
Mr Chote: Yes, as I said, the
total cut required is £36 billion. If you take the Government's
words that they can cover £11 billion of this by efficiency
savings, £3.4 billion by a public sector pay squeeze, £1
billion from public sector pensions and £5 billion from cuts
to lower priority budgets that they have identified, that is taking
20 away and leaving you with 15. There are of course question
marks over all of those thingsefficiency savings amongst
Q51 John Thurso: Do you think the
Government is right then to ring-fence certain areas of spending
or is it not a fact that everything is going to have to come under
Mr Chote: When you say ring-fence
even in the areas the Government claims to be protecting they
are talking about a much less generous settlement than those areas
received during the years of plenty anyway, so I would be slightly
wary of the word "protecting" in that context.
Q52 John Thurso: How about not decreasing?
Mr Chote: As we know from past
Spending Reviews, when these three-year plans are set out, not
everything goes up at the same rate. The Government has clearly
had preferences to focus resources on for example health and schools
in the good years, and you would expect them to wish to continue
to focus resources in those areas when things are tighter as well.
In theory you would like the Spending Review to be a holistic,
strategic exercise in which everything is thought out and all
the pieces of the jigsaw are put in place and then you present
a full set of spending decisions across all departments. That
is not how any Spending Reviews have worked in the past in practice.
On some occasions good news is fed out in advance; in some cases
bad news is fed out in advance. So on this occasion we have had
these comments about protecting the front-line NHS and schools
and Surestart et cetera. One difficulty with this, as I say, in
addition to the Treasury not giving us their estimate of total
departmental expenditure limits, is we do not have a clear idea
of what exactly these protected areas constitute and therefore
what the Government thinks they are spending on them now.
Q53 John Thurso: In summary, the
PBR did not say enough about spending that occurs after the end
of the current Spending Review?
Mr Chote: For that we have to
wait for a full Spending Review which we are not promised before
Mr Weale: Can I make a brief point
about the issue of ring-fencing and particularly with reference
to health. All the international evidence is that as countries
get richer they want to maintain, or possibly increase, the proportion
of their income which is spent on health, and that is a process
that we have seen in the United Kingdom. The Treasury say that
as a result of the crisis, the economy and we are going to be
about 5% poorer than we would have been without the crisis. If
you assume that the tendency for health spending to grow more
than in proportion to the economy actually reflects people's social
preferences then you would say that when you become unexpectedly
poorer, health is one of the earlier things you should be cutting
back on rather than one of the last things you should be cutting
back on, so my sense is that we have seen a short-term political
focus which has perhaps got a bit divorced from what the national
and international evidence suggests to us people's preferences
actually are and the way in which they respond to increases and
decreases in income.
Q54 John Thurso: So somebody is going
to have the courage to cut health spending, is what you are saying?
Mr Weale: Yes.
Q55 Mr Plaskitt: Do any of you see
any significant threat to the UK's AAA credit rating?
Ms Ward: I think the rating agencies
have been quite clear about what the goalposts are on the way
towards a downgrade should they put one in place. As this became
a global crisis and we saw deficits rise all around the world,
the concern was about the structural deficit, and that is obviously
where the UK is of a concern because it is much larger than elsewhere
and it is the structural element that the ratings agencies are
focused on. That was what prompted my question at the beginning
that I felt if there was a lot more transparency about how that
structural deficit had arisen, and how it was likely to be eliminated
going forward, I think that would certainly help the rating agencies
as well as general market participants assess the UK's outlook.
Q56 Mr Plaskitt: So you think there
is some risk?
Ms Ward: S&P have put the
UK on to a negative outlook. They will make a judgment post the
election whether the fiscal consolidation pleases them. Moody's
and Fitch, the other main ratings agencies, have said that they
want to see the outlook for receipts in the recovery, so it is
much less imminent from those ratings agencies.
Professor Dow: On the structural
deficit, we have touched already on the fact that the calculation
of what consists of a structural deficit is full of uncertainty,
particularly in terms of the difference between the cyclical adjustment
and the adjustment to trend. What the structural deficit consists
of depends on the division between the cyclical adjustment and
the trend adjustment, so there is a huge area of uncertainty there
and in any case ratingsthis has been the problem that has
dogged the build-up to the crisis and the crisis itselfare
risk-assessed but they are based on judgment ultimately, and there
is no concrete answer to what the rating ought to be; it is a
matter of judgment and market sentiment.
Q57 Mr Breed: Robert and Martin,
is it useful to legislate for fiscal responsibility?
Mr Weale: I must say, I cannot
really see the point of it. I am not really sure what will happen
has not happened in the past if the deficit turned out to be worse
than the path set out by the legislation. It says in the Pre-Budget
Report that the Chancellor will have to explain what happened
and what he is going to do to remedy the situation, which is not
Q58 Mr Breed: We will ask it on Wednesday.
Mr Chote: I do not think this
is any great advance on the code for fiscal stability which was
legislated back in 1998. The issue of greater independence in
scrutiny and production of the forecast has not been addressed.
Q59 Mr Fallon: Robert, you gave the
figures for spending cuts in 2013, but what is the total spending
increase in this Budget for next year, roughly?
Mr Chote: There is a discretionary
spending increase of roughly 4 billion in 2010-11 rising to 7.7
in 2011-12, 7 in 2012-13 and then beginning to fall back a bit.