More austerity ahead in Britain

This is my Fundweb blog post from 30 November (before the Autumn Statement). Apologies for the delay in posting it but I have had severe technical problems in the past couple of weeks.

A study by the Institute for Fiscal Studies, a highly respected think tank, gives some useful pointers on what next week’s Autumn Statement is likely to look like. Even more fiscal tightening could well be on the way.

The IFS’s conclusions are based on a study of what has happened to the British economy since the forecasts by the Office for Budget Responsibility in March. Since then economic growth has disappointed and tax revenues have been worse still.

Based on this performance the IFS calculates forecasts for public finances based on two scenarios. An optimist one assumes that the recent poor performance was a blip while the pessimistic one starts from the premise that it indicates a new trend.

The IFS then considers whether under the different scenarios the government is likely to meet its two self-imposed fiscal targets:

• Fiscal mandate: the structural current budget must be forecast to be in balance or surplus by the end of the rolling five-year forecast horizon;
• Supplementary target: debt as a share of national income must fall between the fixed dates of 2014-15 and 2015-16.

Even under the optimistic scenario the IFS estimates suggest the government is likely to miss its supplementary target. Debt levels look set to continue to increase in the 2015-16 fiscal year.

Under the pessimistic scenario the government is forecast to miss even its fiscal target under current policies. To stay in line with the mandate the chancellor would need to engage in even greater fiscal tightening:

“He would need to announce a package of tax increases or further spending cuts amounting to 1.5 per cent of national income (or £23bn in today’s terms), to be implemented no later than 2017-18. Such changes would need to be announced now (so that their impact could be incorporated into the official forecast) but their implementation could be postponed until after the planned date of the next general election.”

However, there is one obvious way in which the government could fiddle its figures. Earlier this month, the Treasury announced that excess cash from the Bank of England’s quantitative easing (QE) programme would be transferred to the Exchequer. One of the things to look out for next week will therefore be whether the Treasury attempts to subsume this money into its accounts.

The OBR has made it clear that it would be against such a procedure. It “should not in itself have a significant impact on the eventual aggregate net profit or loss to the Exchequer from QE”. In other words the government should not use the revenue to suggest that the public finances have improved.

However, one note of caution is in order with all such forecasts. They provide a useful way of assessing what the public finances are likely to look like on certain sets of assumptions. From this perspective the IFS consistently does a good job.

The challenge facing politicians is to create a framework for a more dynamic economy. That is to change the conditions on which the assumptions are made.

Rather than meeting arbitrary fiscal targets the challenge for government should be to create the conditions for concerted growth.