Autumn Statement 2012 - Treasury Contents

3  The public finances

Changes announced in the Autumn Statement

42.  The impact of measures announced in the Autumn Statement is summarised below. The Government estimates the fiscal impact to be savings of £3.97 billion in 2012-13, with an increase in spending over receipts of £910 million in 2013-14. Over the forecast period, the net impact is a saving of £6.47 billion.Table 2: Overall fiscal impact of Autumn Statement measures
£ million
  2012-13 2013-14 2014-15 2015-16 2016-17 2017-18
Total tax policy decisions -870+180 -2,385-905 +295+305
Total spending policy decisions +4,840-1,090 +1,465- -+4,635
TOTAL POLICY DECISIONS +3,970-910 -920-905 +295+4,940
Source: HM Treasury, Autumn Statement 2012, 5 December 2012, Table 1, p 9

Performance against the fiscal targets


43.  The OBR is responsible for assessing the Government's performance against the fiscal mandate and the supplementary target:

The Charter for Budget Responsibility defines the fiscal mandate as "a forward-looking target to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period". This means that total public sector receipts need to at least equal total public sector spending (minus spending on net investment) in five years time, after adjusting for the impact of any remaining spare capacity in the economy. For the purposes of this forecast and the spring 2013 EFO [Economic and fiscal outlook], the five-year horizon ends in 2017-18.

The Charter says that the supplementary target requires "public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16, ensuring the public finances are restored to a sustainable path." The target refers to public sector net debt (PSND) excluding the temporary effects of financial interventions.[79]

44.  The OBR stated in its December 2012 Economic and fiscal outlook that there was a greater than 50 per cent chance of the Government meeting the fiscal mandate, albeit by virtue of extending austerity measures a further year into 2016-17. The cyclically-adjusted current budget was forecast to be in surplus by 0.9 per cent of GDP in 2017-18—the current target year for the purposes of the mandate—and by 0.4 per cent in 2016-17.[80]


45.  The OBR forecast that the Government is unlikely to meet its supplementary target. Public sector net debt (PSND) is forecast to rise by 1 per cent of GDP in 2015-16 and then fall by 0.8 per cent in 2017-18, thereby missing the target by one year. The OBR had forecast that the target would be met in its March 2012 EFO, but has since revised down nominal GDP growth, revised upwards net borrowing and factored in the effect of reclassifying Bradford and Bingley and Northern Rock Asset Management as public sector liabilities. The effects of these revisions are offset to a degree by the transfer to the Treasury of the surplus balance in the Bank of England's Asset Purchase Facility (APF).[81]

46.  The Government has chosen not to implement further cuts in order to meet the supplementary target. The Chancellor effectively acknowledged that doing so could harm the economy. He stated that:

one of the central judgments of this Autumn Statement was not to chase the debt target, in other words, to accept that we had missed the debt target, and had we chased the debt target, that would have required significant cuts or tax rises over the next couple of years.[82]


[…] faced with this choice—hit the target and potentially damage the economy in doing so, or miss the target and help the economy—I decided to help the economy.[83]

The Autumn Statement says that:

At this time of rising debt, the Government will restore debt to a sustainable, downward path and will retain the existing supplementary debt target. As set out in the June Budget 2012, the Government will set a new target once the exceptional rise in debt has been addressed.[84]

47.  Mr Mortimer-Lee stated that the existence of a fiscal framework was in principle valuable but that:

[t]he fiscal framework should be a guide to action and should constrain the Government's ability to come up with policies that suit the short term but not the long term. The rule helps to achieve that but it is not set in stone. We don't fall off the end of the earth if we go past it.[85]

48.  The Government is forecast to meet the rolling fiscal mandate by cutting non-investment spending as a share of GDP for a further year, but not the supplementary target. It has decided not to propose further spending cuts or tax rises in order to meet the latter. The possible failure to meet the supplementary target raises the question of the continuing credibility of that target. Successive governments have committed themselves to, but then failed to meet, their fiscal targets. For a fiscal target to be credible, it must be durable, and therefore not subject to frequent revision as circumstances change. It must also be capable of accommodating conditions different from those at the time the target was first formulated. Nor should a fiscal target be open to manipulation. It is not the case, though, that a target is valuable only so long as it is met. A target can remain credible, and so constrain a government's choices, even if it is not being met, so long as the political commitment that created it continues to inform policy decisions.

49.  The supplementary target remains in place for the moment. The Government has said that it will set a new target, but its timetable is vague: it will do so "once the exceptional rise in debt has been addressed". When the Government does decide to create a new fiscal framework, it should do so only after full public consultation. The Committee will return to this issue.

Credit rating

50.  We questioned witnesses on the likelihood and impact of a downgrade of the UK's AAA credit rating. Mr Hayes and Professor Booth both thought that a downgrade was likely.[86] Mr Hayes, when asked if there would be a downgrade in 2013, replied:

I think it is quite likely. There are two reviews coming up that we know of. Early in the year, probably January, Moody's is looking to revisit this, and in March I think Fitch are looking to review also. In particular as I understand it with Fitch, we are on negative outlook, and on their criteria that implies more than a 50% chance of a downgrade. That was instigated in February this year, I think, since when things have got worse. So it seems to me that things are moving clearly in that direction,[87]

51.  As to the potential impact of such a downgrade, both Professor Booth and Mr Johnson stated that the rating agencies based their decisions on the same information available to the broader market and that therefore any expectations of a downgrade would already be priced into the cost of UK debt.[88] Mr Hayes noted that France did not appear to have suffered material rises in borrowing costs following the downgrades of its sovereign debt. Mr Hayes stated that "the likelihood of a leap in bond yields from a rating downgrade is negligible."[89]

52.  The weight that the Government places on maintaining the UK's AAA rating has shifted over time. The Chief Secretary to the Treasury stated in June 2012 that the "UK government […] has re-established our country's financial credibility. And the credit rating agencies rate the UK as triple A. The low interest rates today of 1.8 per cent are a consequence of this."[90] In contrast, the Chancellor now maintains that the relevant measure is the rate at which the UK can borrow in the international capital markets: "the ultimate test is what you can borrow money at."[91] Mr Mortimer-Lee agreed on the relative unimportance of the rating itself:

The AAA rating to me doesn't matter that much. What matters is what the UK can borrow at and that we have the right policies. Having a label attached to us might be nice in some sense, but does it really matter? I don't think it does. I would agree that the cost to the UK might be about 25 basis points on borrowing costs of losing it, but we should do the right things for the right reasons and not just because the rating agencies will mark us down.[92]

UK cost of borrowing

53.  The Committee heard conflicting evidence on the reasons for the UK's low borrowing costs. Mr Portes of NIESR stated that:

we do not observe any observable correlation between changes in deficits for countries like us, which have floating exchange rates and an independent monetary policy, and gilt yields. So long as the markets perceived the Government as having some reasonable plan to balance public finances in the long-term, the particular form that plan took was not relevant.[93]

In Mr Portes' view, economic theory suggested that the Government's borrowing costs should in fact rise as the economy improves:

If you thought that falling gilt yields or falling spreads reflected increased confidence in UK plc, increased confidence in the economy and all the rest of it, then you would have to believe that, when gilt yields fell, the stock market would do well. That is pretty simple. Is that what we observed? It is absolutely not what we observed. If you look at day-to-day movements, especially around the time when we were going through this supposed crisis during 2010, the correlation between gilt yields and equity prices goes exactly the wrong way. In other words, when gilt yields went up, equity prices went up as well. In other words, when people were feeling more optimistic, gilt yields went up. When people were feeling less optimistic, yields fell. It is not about credibility, it is about what you think is going to happen to the economy. Economic weakness leads to low long-term interest rates. This is really very basic macro-economics.[94]

54.  In contrast, Professor Booth, whilst recognising that there were several factors contributing to the UK's low borrowing costs, believed that one factor was "reasonable credibility with regard to the Government's financial plans."[95] But witnesses noted the difficulty of decomposing the factors explaining the rate at which the UK currently borrowed,[96] with Mr Chote stating that "what is in the price clearly is the sum of the market's views of current policy."[97]

Asset Purchase Facility transfer

55.  On 9 November 2012, it was announced that the cash surplus held in the Bank of England's APF was to be transferred to HM Treasury. This means that any surplus or deficit generated as a consequence of the operation of the Bank's quantitative easing (QE) programme is reflected in the public finances on an ongoing basis rather than as a one-off change when QE is unwound. The Government and the Bank both maintain that this decision was simply a matter of efficient cash management, and similar to the practice of the Federal Reserve in the United States.[98]

56.  There was some discussion concerning the effects of the transfer on the fiscal mandate and supplementary target. Public sector net debt will be reduced during the spending review period by £71 billion, though as monetary policy tightens and QE is unwound, this will reverse and will lead to an increase in net borrowing.[99] The OBR estimates that the net impact upon completion of the unwinding of QE will be a small gain to HM Treasury of approximately £55 billion. In assessing this potential impact on public sector net debt and the eventual outcome of QE's unwinding, the OBR was constrained by the fact that the Office for National Statistics has yet to state how it will treat the transfer in the national accounts. The OBR presented in its forecasts the effect of the Asset Purchase Facility transfer, and set out its assumptions in modelling the unwinding of Quantitative Easing. This transparency is welcome.

57.  The Governor acknowledged to us that the transfer of the APF surplus was equivalent in effect to further monetary stimulus, stating that "it certainly affected monetary conditions, in the sense that it was broadly equivalent to a stream of asset purchases over the next year of £37 billion."[100] On 8 November 2012, the Bank of England issued a press release following the monthly meeting of the MPC in which no further QE was announced. The press release did not mention the APF transfer or its effect on monetary conditions.[101] The Governor confirmed to us, however, that the MPC had known about the APF transfer at the time of its November meeting.[102] The information about the APF transfer became public the following day, with the release of letters between the Chancellor and the Governor detailing the transfer.[103]

58.  This raised questions as to whether the Treasury had usurped the role of the independent Monetary Policy Committee in implementing monetary policy. Chris Giles, in a piece for the Financial Times entitled "Policy ploys risk UK economic credibility", argued that:

What about the independent Bank of England? Sir Mervyn King confirmed yesterday that the interest rate setters viewed the Treasury's actions as equivalent to £37bn of monetary policy easing in the first year. So the Monetary Policy Committee appears to have acquiesced in an easing it had not initiated, after misleading the public that it had kept monetary policy unchanged when it took its monthly decision last Thursday. Allowing the Treasury to initiate monetary policy suggests the MPC has lost the plot; it certainly does not know how to communicate changes in monetary policy any more.[104]

59.  When questioned about this possible infringement of the MPC's independence, the Governor said that the transfer did not cause concern for him as it was within the MPC's power to negate its effects.[105] Dr Martin Weale and Dr Ben Broadbent, both members of the MPC, likewise did not feel that HM Treasury's decision affected their capacity to reach independent decisions about monetary policy.[106] Indeed, they both noted that they had in fact been minded to support further QE, but on being informed of the APF surplus transfer had decided there was therefore no need for further QE.[107] Yet Mr Wells argued that the way the decision was communicated was also important:

I think it was communicated rather clumsily. I think it should have been thought of well in advance of when it was done, because it could have perhaps been announced during a Bank of England inflation report and explained very clearly. As it was, the day after quite a big policy announcement, suddenly being announced and then the MPC saying, "Oh well, if we had wanted to offset it, we knew it was coming; we could have changed", I think was slightly unsatisfactory.[108]

60.  The Governor acknowledged that the perception of the MPC's independence was important in its own right:

it is very important that we go beyond [independence] and ensure that not only is our independence not compromised, which I think is the case, but has not been seen to be compromised. That also matters […][109]

But when we questioned the MPC on why it had not published any announcement on the APF at the time of the 8 November press release, the Governor argued that it was not in the MPC's gift to publicise the transfer.[110] The Governor conceded that, in relation to the timing of the announcements, "I think it is unfortunate if people were misled, and I think that is a matter for regret".[111]

61.  The perceived independence of the MPC is of paramount importance for the effective execution of its duties. We acknowledge that the MPC had the opportunity at its November meeting to take steps to negate the impact on monetary conditions of the APF transfer. The MPC's actual independence was therefore not threatened. But by not announcing the monetary easing that arose from the APF transfer to the Treasury at the time of its regular November press release, the MPC gave the impression that the Treasury was undertaking monetary policy, rather than the MPC.

62.  The MPC needed to be in a position to publicise the transfer at the time of its press release in order to fulfil its duty to act transparently and to demonstrate its independence. Had the MPC decided that it needed to negate the effect of the APF transfer by reducing QE, it would have had to reveal the APF transfer in order to be able to explain its decision. Deciding not to cancel out the effect of the APF transfer was also a decision that the MPC took which deserved public explanation, especially as we know that the transfer influenced MPC members' decision-making. The Bank of England should, therefore, have ensured that the MPC was in a position to make the fact of the APF transfer public at the time of the publication of its November press release. A satisfactory alternative would have been for the Treasury to have announced the transfer at the same time as, or before, the release of the MPC's minutes. The Treasury and to some extent the Bank were at fault for failing to coordinate the announcement of the APF transfer with that of the November MPC press release, the date of which was known well in advance. This failure created difficulties for the reputation of the MPC. This should not be repeated.

79   Office for Budget Responsibility, Economic and fiscal outlook, December 2012, p 173 Back

80   Office for Budget Responsibility, Economic and fiscal outlook, December 2012, p 18 Back

81   Office for Budget Responsibility, Economic and fiscal outlook, December 2012, p 18 Back

82   Q 290 Back

83   Q 311 Back

84   HM Treasury, Autumn Statement 2012, 5 December 2012, p 31 Back

85   Q 141 Back

86   Qq 145, 151 Back

87   Q 145 Back

88   Qq 152, 200 Back

89   Q 142 Back

90   Speech by Chief Secretary to the Treasury, Rt Hon Danny Alexander MP; Glasgow Chambers of Commerce, 21 June 2012 Back

91   Q 322 Back

92   Q 144 Back

93   Oral evidence to the Treasury Committee, National Institute of Economic and Social Research Quarterly Review, October 2012, Q 13 Back

94   Oral evidence to the Treasury Committee, National Institute of Economic and Social Research Quarterly Review, October 2012, Q 44 Back

95   Q 159 Back

96   Q 159 Back

97   Q 91 Back

98   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 66 Back

99   Office for Budget Responsibility, Economic and fiscal outlook, December 2012, p 15 Back

100   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 39 Back

101   Bank of England, Press release: Bank of England maintains Bank Rate at 0.5% and the size of the Asset Purchase Programme at £375 billion, 8 November 2012 Back

102   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 45 Back

103   Letter from the Chancellor to the Governor, HM Treasury website 9 November 2012; letter from the Governor to the Chancellor, Bank of England website, 9 November 2012 Back

104   Financial Times, Policy ploys risk UK economic credibility, by Chris Giles, 14 November 2012 Back

105   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 39 Back

106   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Qq 74, 75 Back

107   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Qq 74, 76 Back

108   Q 131 Back

109   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 97 Back

110   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 46 Back

111   Oral evidence to the Treasury Committee, Bank of England November 2012 Inflation Report, HC 767, Q 71 Back

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Prepared 29 January 2013