The Autumn Statement and the Charter for Budgetary Responsibility

Angus Armstrong, Francesco Caselli, Jagjit Chadha, Wouter den Haan 23 December 2015

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In the Autumn Statement on 25 November, the Chancellor and the Office for Budgetary Responsibility (OBR) unveiled forecasts for real GDP growth to lie at or above trend for the rest of this Parliament – in the range of 2.3-2.5% – and for CPI inflation broadly to return to the target of 2%. Public sector net borrowing is forecast to fall to 3.9% of GDP in 2015-16 and then to fall each year for the remainder of the forecast period. We reproduce the top panel of Table 1.2 from the OBR’s Economic and Fiscal Outlook for November 2015, published in conjunction with the Autumn Statement:

Table 1. From the OBR’s Economic and Fiscal Outlook

Source: Office for Budget Responsibility (2015).

The OBR forecasts that the public finances will return a surplus of £10.1 billion in 2019-20 and £14.7 billion in 2020-21. Public sector net debt is forecast to fall each year, reaching 71.3% of GDP in 2020-21 (HM Treasury 2015a). As well as benefitting from some upward revisions to the level of nominal GDP, fiscal consolidation is being achieved by a mix of asset sales, tax increases and welfare cuts.

Depending on estimates of the fiscal multipliers, the extent of spare capacity, the need to maintain low levels of debt in order to deal with a future financial or economic crisis and the impact of any future debt sales on interest rates for UK government debt, one may take issue with the planned path of fiscal consolidation.

Is the path of fiscal consolidation appropriate?

This month’s first question asked respondents whether or not they agreed that the Chancellor’s planned rate of fiscal consolidation is broadly appropriate.

Q1. The Chancellor forecasts a cyclically adjusted fiscal surplus by 2017-18 and in cash terms by 2019-20. Do you agree that this planned path of fiscal consolidation is appropriate?

Figure 1. Is planed fiscal consolidation appropriate?

Note: Left panel is unweighted; right panel is weighted by confidence.

Twenty-six of our panel of experts responded to this question, of which 31% agree or strongly agree, 23% neither agree nor disagree, and 42% disagree or strongly disagree. The respective shares when weighted by the confidence with which respondents hold their opinions are 35%, 19%, and 45%.

Many of those who agree feel that at this stage in the economic recovery, it makes sense to aim for a fiscal surplus. George Buckley (Deutsche Bank) argues that “to arrive at a balanced budget over the next few years requires roughly 1% of GDP consolidation (i.e., reduction in the cyclically adjusted deficit) per year over the course of this parliament. While that is sizable it is achievable in the event that the economy performs as expected.”

Patrick Minford (Cardiff) further argues that the recovery will increase the costs of debt service: “The world is now moving towards a normalisation of interest rates and there will also be a continuation of global recovery which will strengthen the rise in real rates. The cost of servicing public debt will sharply increase; no longer will the government be able to enjoy the financial repression we have seen to date.”

Wouter Den Haan (LSE) uses a precautionary reason as a rationale for surplus: “The UK economy is doing well, but there are downside risks (Brexit, Eurozone trouble, refugee crisis). Fiscal consolidation now will put the UK in a better position to act if the need arises.”

There are two sets of arguments used to justify disagreement. The first is that the levels of debt are not a great problem with Ethan Ilzetzki (LSE) arguing that “the level of public debt in the UK has not been a significant risk throughout the crisis”, and Simon Wren-Lewis (Oxford) suggesting that “a period of low interest rates and low real wages is a time to substantially increase public investment… continued surpluses will put all the burden of adjustment on the current generation.”

Others argue that although consolidation is necessary, the pace is too rapid. Martin Ellison (Oxford) thinks that “it remains unclear whether the speed of fiscal adjustment is correct or what its distributional impacts might be. There is a possibility that premature fiscal tightening may jeopardise the recovery of the UK economy, and that welfare cuts affect some people disproportionally in what is ultimately one of the richest large countries in the world.” Michael McMahon (Warwick) does not think that “the planned (quite aggressive) spending cuts are necessarily needed at this point and so falling short of the planned cuts would be desirable. If the fiscal surplus is to be achieved, I hope it is because a continued recovery allows revenue collection to meet or surpass its target.”

The Charter for Budgetary Responsibility

To help bolster fiscal credibility, the Chancellor has implemented two key reforms of the process of setting fiscal policy. First, in 2010 the OBR was established as a ‘fiscal watchdog’, which, inter alia, provides an independent assessment of the long-term sustainability of the public finances and provides forecasts of the economy and the public finances. Second, in the post-election 2015 Summer Budget, the  Chancellor announced a Charter for Budgetary Responsibility (HM Treasury 2015b).  

The new fiscal policy framework sets two clear objectives for fiscal policy:

  1. to achieve sustainable public finances; and,
  2. to support the effectiveness of monetary policy.

The resulting mandate is in two parts. In ‘normal times’, when a headline surplus has been achieved, the Treasury will target a surplus on public sector net borrowing every year.

At other times, where there has been a significant negative shock to real GDP growth1, which is identified by real GDP year-on-year growth in unrevised data of less than minus 1%, the target for a surplus is suspended and a plan for fiscal targets to return to surplus must be presented by the Chancellor and approved by a vote in the House of Commons.

Given the problems of identifying the economic cycle in real time and the complexity of understanding the underlying fiscal position, there might be thought to be a question mark as to whether fiscal policy can be expressed as a simple rule such as the one implied by the Charter. The rule might also be thought not to be especially binding on future Chancellors and therefore of limited value. This month’s second question asks whether or not you agree that the Charter for Budgetary Responsibility is helpful in underpinning the credibility of fiscal policy.

Q2. Do you agree that the Charter for Budgetary Responsibility is helpful in underpinning the credibility of fiscal policy?

Figure 2. Will Charter for Budgetary Responsibility improve fiscal policy?

Note: Left panel is unweighted; right panel is weighted by confidence.

Twenty-six of our panel of experts responded to this question, of which 38% agree or strongly agree, 15% neither agree nor disagree and 46% disagree or strongly disagree. The respective shares when weighted by the confidence with which respondents hold their opinions are 36%, 11%, and 53%.  The debate seems to revolve around the usefulness of a fiscal rule stated in terms of the deficit and whether the targets are either credible or socially optimal.

Panicos Demetriades (Leicester) sums up the mood of those who agree by arguing that “it's a step in the right direction, which can help enhance the credibility of fiscal policy, although on its own it is not sufficient to ensure fiscal responsibility. Fiscal policy remains in the hands of democratically elected politicians; if they have other priorities they will always find ways around fiscal rules.” Ricardo Reis (LSE) goes further: “This particular rule both takes into account the need to pay for the debt, as well as the desire to respond to the economic cycle. Moreover, by setting regimes and limits, it still allows for considerable discretion in responding to different data while acknowledging that the Chancellor cannot perfectly target a value for the deficit. Of course the rule could be improved, but it is a decisive step in the right direction for fiscal policy.”

For those who disagree, Jonathon Portes (NIESR) sums it up as follows: “The Charter is poorly designed, and indeed represents a significant step backward compared to the fiscal framework that operated during the previous Parliament… There is absolutely no doubt that (as in the last Parliament, but against the backdrop of a much more elastic fiscal rule) it would, entirely sensibly, allow the progress of deficit reduction to slip again. In other words, for the period of this Parliament, the new fiscal rule is simply incredible, in the strict sense of the term – nobody should believe it.”

David Cobham (Heriot-Watt) agrees: “At the end of the day the Charter will weaken credibility, because the strains it imposes on public expenditure (now becoming more and more visible) will make reneging on the Charter come to seem more and more likely (c.f. Argentina's currency board in the 2000s).” 

John Van Reenen (LSE) feels that the “obsession with public debt is very harmful to sensible policymaking. We need to consider the assets side of the balance sheet, not simply the debt side. Credibility is not enhanced by setting such targets or having silly laws that can be revoked when needed. At best it leads to financing gimmickry with the public accounts (e.g., manipulating the timing of sales and recording of public assets); at worst it leads to premature austerity and serious reductions in growth and welfare”.

References

HM Treasury (2015a), "Spending review and Autumn Statement 2015", Presented to Parliament by the Chancellor of the Exchequer by Command of Her Majesty, Cm 9162, November.

HM Treasury (2015b), "Charter for Budget Responsibility: Summer Budget 2015 update", July.

Office for Budget Responsibility (2015), "Economic and fiscal outlook", Presented to Parliament by the Economic Secretary to the Treasury by Command of Her Majesty, Cm 9153, November.

Endnotes

[1] The negative shock will count if it has occurred in the “most recent 4 quarter period; is occurring at the time the assessment is being made; or will occur during the forecast period”, (HM Treasury 2015b: 7).

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Topics:  Macroeconomic policy

Tags:  macroeconomic policy, Autumn Statement, budget, debt reduction, fiscal policy

Director of Macroeconomic Research, National Institute for Economic and Social Research

Professor of Economics at the London School of Economics

Director, National Institute of Economic and Social Research

Professor of Economics and Co-Director of the Centre for Macroeconomics, London School of Economics and CEPR Research Fellow

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