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Economics: Nobody’s Darling

Dennis Turner

A virtual industry has been created around the Budget. Newspapers have
in-depth supplements previewing the Chancellor’s options, television coverage
approaches saturation on Budget day, economists pronounce with certainty on the
impact the Chancellor’s statement will have on spending and interest rates,
while accountants spend a fortune on receptions to brief clients on its meaning.
So much of it is, of course, just hype.

For a host of reasons, the significance of the Budget has progressively
diminished. Many of the details are now trailed in the previous autumn’s
pre-Budget report, interest rates matter more than fiscal policy for day-to-day
economic management and the net effect of the tax changes rarely amounts to more
than one-half of one per cent of GDP. (In the case of this year’s Budget,
Alistair Darling’s proposals will take less than £2bn out of the economy by
2010-11.) But it remains a major political set piece, the Chancellor’s big
opportunity to shine, to set out where the government is going and to put the
opposition on the defensive.

Everyone knew that Darling did not have much of a hand to play. Since 2001,
when Gordon Brown stepped up spending on public services, the government’s
finances have steadily deteriorated. Borrowing has regularly exceeded forecasts,
the tax burden has been rising and debt (even excluding huge hidden liabilities
for public sector pensions and Northern Rock) has been increasing. And this has
occurred at a time when the economy was growing. Now, the Chancellor has to get
government finances back on track, but against a much more unhelpful economic
backdrop.

It was the Treasury’s view of the economic outlook that was of particular
interest to economists. The buoyancy of recent years has evaporated, but markets
wondered how bad the government felt the situation was likely to get. And here,
rather predictably, Darling tried to shift responsibility for some of our woes
on to the world economy, when, in fact, much of the problem is home-grown.
Excess consumption and borrowing by households and government have led to an
unbalanced economy and a correction is long overdue. Any correction, moreover,
will take time and be a gradual process.

Last year was a cracking year for growth, with GDP increasing by 3.1%. For
much of 2007, the Treasury was saying more of the same this year, but by the
autumn, they had scaled the forecast back to 2.25%. In his Budget, Darling
reduced it further, to 2%, before growth gets back on trend (2.5%) next year and
climbs to 2.75% in 2010. This is very much at the optimistic end of the range.
Although few people expect a recession, 1.5% growth looks nearer the mark for
this year with a slower recovery in subsequent years.

Also curious (but honest) was the above-target 2.5% forecast for (CPI)
inflation in Q4 this year. Although the Treasury does not forecast interest
rates, some deductions can be made from its numbers. If inflation is this high
(and there are real risks of it rising from the current 2.2% rate), and Darling
is right about growth, it suggests not only that the MPC will not have the scope
to cut interest rates much below 5%, but also that the need to do so is less
compelling.

Many independent forecasters, believing that activity will be much weaker,
have pencilled in interest rates at 4.5% by the end of 2008, which would almost
certainly lead to sterling slipping, thus boosting exports. But in the Treasury
scenario, higher rates and stronger sterling may stifle the much-needed export
effort. Higher rates will also keep the pressure on the heavily indebted
personal sector and hold back the housing market. All of this points to growth
slowing, unless the economy is currently stronger than is widely assumed.

When he took over at the Treasury in 1997, Brown set out the criteria by
which he wanted the government’s tax and spend policies to be judged. It is
perhaps in the context of the two fiscal rules that the optimistic growth
projections are best understood. According to the Budget numbers, both the
Golden Rule and the Sustainable Investment Rule are met, but it is a close run
thing. Slower growth and weaker tax revenues would probably mean more borrowing,
and the breaching of the rules. Even so, the government has needed to define the
rules on its own terms (and change the definition on more than one occasion) to
make sure they were met. Any breaching of the rules would not lead to the
economy faltering, but would certainly undermine the government’s claim to
“prudence”.

From the point of view of the economy as a whole, the Chancellor’s speech
seemed to confirm that the Budget matters less and less. He was in no position
to offer a stimulus to flagging activity, did little to rebuild the government’s
credibility with the business community (after the CGT and non-doms
controversies) and at best tinkered with some of the government’s key social
priorities (pensioners and the environment). But in fairness, we are probably at
a point in the political cycle that does not require heroics, and Darling is
clearly the right man for this situation.

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