The autumn statement has two objectives in the British budgetary process. It provides an updated economic forecast and it makes a mid-course correction in fiscal policy, if thought necessary in light of the new outlook. George Osborne had a tricky task in front of Parliament on Tuesday. He had to admit to a much gloomier outlook, while justifying his decision to stick to the multi-year deficit reduction plan that he laid out last spring. With some clever footwork, he managed to square this circle.
Previous chancellors had more room to manoeuvre. They could, and did, tilt their forecasts to align with their desired policy outcomes, as Alistair Darling describes in his recent book. Much post-budget commentary used to focus on the credibility of the Chancellor’s forecast. Those days ended with the establishment of the independent Office of Budget Responsibility. It provided a stiff rod for Mr Osborne’s back.
He did not attempt to belittle or explain away the OBR’s starkly downgraded growth forecast. Instead he highlighted their analysis that the expected stagnation for the next two years (less than one per cent growth per year) was due to the eurozone debt crisis, the squeeze on UK households from external rises in fuel and food prices, and lower trend growth. The last is a judgement call that may prove too gloomy, but the Chancellor accepted it for now.
The autumn statement was delivered against the backdrop of extremely febrile conditions in the bond markets, and battered business and consumer confidence at home. Mr Osborne used a two-pronged approach to address these challenges. To reassure the markets, he stressed policy stability in the UK, which contrasts strikingly with the policy uncertainty and political turbulence abroad. The British coalition government is unique among the major economies in having an electoral mandate for deficit reduction and a long election-free future to achieve it. The bond markets have recognised and rewarded this superior political capital, along with Britain’s exchange rate flexibility, with significantly lower interest rates. Mr Osborne noted that even a one per cent rise in the cost of government debt would cost £21bn in higher interest payments – and neighbouring countries have seen rises of five per cent in just a few weeks once credibility is lost. This is an advantage the Chancellor took great pains to retain. It is also a politically useful bit of clear water between the coalition’s fiscal strategy and that of the opposition Labour party.
The task of restoring confidence was addressed by laying out a medium-term growth strategy based on infrastructure investments already identified, mainly for road and rail improvements, and targeted incentives for small and medium businesses. Public sector expenditure is necessarily limited but if the bulk of the investment can be obtained from UK pension funds and external sovereign wealth funds, so much the better for the British taxpayer. This will require firm long-term contracts, which themselves rest on a stable tax and policy environment.
Policy stability means sticking to the announced public spending cuts and pension reforms that will have a big cumulative impact on curbing government debt. It does not mean inaction or callousness in the face of slower growth. The built-in stabilisers, such as unemployment compensation and the pension credit, will continue to provide income support to the vulnerable.
A tight fiscal stance provides the space for the Bank of England to continue with a loose monetary policy. Both will cushion the effects of the downturn. The cap on fare increases by trains and buses will also keep inflation down in the short-term, which will help the Bank’s credibility with the public.
Mr Osborne’s autumn statement, overall, was a strong defense of the coalition’s unchanged fiscal strategy coupled with a set of small, but cleverly targeted, incentives to promote investment and growth. The test of success will rest with the market response over the next week, and the strength of the economic recovery over the rest of this Parliament. But just as Gordon Brown’s watchword while he was chancellor was ‘prudence’, Mr Osborne’s should be ‘stability’. Only time will tell if he lives up to his word better than Mr Brown did.
This commentary appeared in The A-list blog on FT.com on 29th November 2011