The madness of Chancellor George

No Chancellor in the past 100 years has delivered his fourth Budget having presided over a worse growth performance than George Osborne did today. The economy is just 0.7% larger than when he took office, well below the 5.5% the Office for Budget Responsibility (OBR) predicted when it published its first forecast in June 2010. And an unprecedented triple-dip recession is on the cards (although, unsurprisingly, not in the OBR’s forecast).

Successive OBR GDP growth forecasts OBR GrowthSource: OBR and Datastream

This weaker-than-expected growth has blown a hole in George Osborne’s plans to place the UK’s fiscal position on a more stable footing. While the OBR’s forecast in June 2010 envisaged that the deficit would be cut from 10.1% of GDP in 2009-10 to 5.5% of GDP by 2012-13, the OBR now expects the underlying deficit to be 7.8% of GDP this year, down just a tenth of a percentage point compared with 2011-12. The deficit is not now expected to fall below 3% of GDP until 2017-18. Government debt, meanwhile, having in June 2010 been expected to peak at 85.5% of GDP this year, is now expected to peak at 100.8% of GDP in 2016-17. And, for all of the OBR’s forecasts, the risks have to be seen as to the downside given recent experience, implying lower growth than expected, and higher deficits.

Successive OBR public sector net borrowing forecasts*

OBR Public Sector Net Borrowing*Excluding Royal Mail pension transfer and receipts from the BoE's Asset Purchase Facility. Source: OBR and Datastream

No wonder that, in the run up to today’s Budget, the Chancellor was on the receiving end of plenty of advice that a change in policy direction was required. Predictably, however, this advice was ignored. Instead, the main thrust of the fiscal consolidation effort was kept in place, with the Chancellor merely tinkering at the edges, including a reduction in the corporation tax rate to 20% from April 2015 and a reduction in current spending over the next two years to finance an increase in infrastructure spending.

Overall, therefore, the Budget was effectively neutral in terms of its impact on growth. So, having eschewed fiscal activism, the Chancellor instead is pinning his hopes on monetary policy to rescue the economy (and his party’s electoral fortunes). Here he announced, undoubtedly with one eye on the arrival of the new Governor in July:

  • an alteration in the MPC’s remit that, while leaving the existing 2% inflation target in place, provides the MPC with more leeway for inflation to diverge from the target over prolonged periods;
  • in addition, the MPC has been asked to provide an assessment of the possible use of forward guidance and intermediate thresholds (as currently employed by the Fed) in its August Inflation Report (the first to be overseen by Mark Carney), and;
  • an ongoing review by the Treasury and the BoE to examine potential extensions to the funding for lending scheme (FLS).

The changes to the MPC’s remit are hardly earth shattering – the first part merely makes official the de facto actions of the Committee over recent years, while the MPC could presumably have introduced forward guidance if it had wanted to anyway. In any case, it is far from clear that monetary policy, by itself, can get the UK economy out of its current funk. Interest rates are already close to record lows right across the maturity spectrum – it is not obvious that trying to push them lower through another round of QE or forward guidance on keeping rates low will do anything to boost lending significantly. The same goes for attempts to turbo charge the FLS. Private sector borrowing will only increase when growth, and hence confidence, returns. And only the government has the power, by itself, to inject sufficient resources into the economy to kick start growth. With rates at record lows, the government should be borrowing more now to invest in the UK’s woefully inadequate infrastructure. Those, such as the Prime Minister, that argue that it’s not possible to borrow less in the long run by borrowing more now, should read this.

It is said that the definition of madness is doing the same thing over and over again and expecting a different result. That nicely sums up the approach taken by George Osborne in today’s Budget. And, with the Chancellor and Prime Minister having said in the clearest possible terms that they’re not for turning, the current self-defeating approach to economic policy looks set to remain in place until at least the next election in 2015, leaving growth elusive and deficit targets repeatedly missed. Of course, this will likely eventually prove electorally self-defeating too. But the inheritance he will leave his successor will be much worse than the one he himself received - an economy with poor and declining growth potential, a far higher and still-rising debt stock than when he took over, and yet most of the fiscal tightening still to be done.

Successive OBR gross government debt forecasts*

Successive OBR

*Maastricht definition. Source: OBR and HM Treasury


Grant Lewis, Head of Research

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