Pre-Budget Report 2009 - Treasury Contents


Examination of Witnesses (Question Numbers 40-59)

PROFESSOR SHEILA DOW, MS KAREN WARD, MR ROBERT CHOTE AND MR MARTIN WEALE

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 easing.

  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 you.

  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 words—in 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 things—efficiency savings amongst them.

  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 the microscope?

  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 the election.

  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 ratings—this has been the problem that has dogged the build-up to the crisis and the crisis itself—are 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 convincing.

  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.



 
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