Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 20 - 43)



  20. Ms Barker, there are systematic errors in forecasting; the surplus is always under-predicted. Can we go on like that?
  (Ms Barker) Under this government the surplus has been under-predicted. We have, of course, had previous periods under other administrations where it has gone the other way. Notoriously under the Conservatives VAT revenues came in under what people were expecting and the government ran into the opposite difficulties. This is always the problem that the Chancellor has. I agree with Geoffrey; you would not want to start from here but, in some sense, how much is it the Chancellor's fault he started from here? I do not believe the Treasury have been deliberately under-forecasting the tax take, but they have got more and more tax in. You can see in the Red Book the efforts there have been to to try and work out why; but there is no very strong impression gained for me from the Red Book that they have decided exactly why. In those circumstances, I have some sympathy with the Chancellor announcing a bigger relaxation and it at first sight seemed strictly prudent because he presumably does not want to have yet another year where we are going to end up at the end of it discovering that we have come up with a much bigger surplus because, rather than moving towards a position where Geoffrey would say "I would like to start from here", we would be moving in the opposite direction. We would be back here next year having the same debate but with slightly larger numbers.

  21. Taking Mr Dicks' formulation, do you think the problem is that we have been over-taxed or under-refunded?
  (Ms Barker) It is difficult to draw the distinction. There was a discussion earlier about how much of the tax rise has been discretionary increases—I think that was the term people used—and, of course, to work out what the discretionary increases were you would go back and gauge the Chancellor's intention by adding up all the Red Books and that is where the difficulty lay in answering the question because there is a considerable difference between adding up all the Red Books and looking at what has happened. My view is that the Chancellor, in terms of what he has done in a discretionary way, made pretty much all the right decisions. He has found that more money has come in and, in my view, he has handed it back to individuals as quickly as has been prudent—and I am using "prudent" here not in the sense of meeting fiscal rules but in the sense of not creating huge difficulties with the Bank of England and inflation. We are in the position, however, where judgments about whether or not he has exactly achieved that in the sense of not creating difficulties for the Bank of England differ. I have taken a slightly different view from my colleagues on this who are giving evidence now and I say that I do think this Budget is still just the right side of prudent.

  22. I wonder if I could ask you, on the question of the fiscal forecasts, whether you think that they are going to go on understating the degree of surplus?
  (Mr Weale) I think that they have an element of that built into them.

  23. Do you think there is a design fault?
  (Mr Weale) As the Red Book makes clear, the fiscal forecasts are made on the assumption that GDP will grow two and a quarter per cent. You may remember that when the current Government came to power it trumpeted that it was reducing its estimate of the trend rate of growth of the economy from two and a half per cent to two and a quarter per cent for the purposes of fiscal forecasting. I think many people outside Government would say that the trend rate of growth of the economy is two and a half per cent per annum or perhaps slightly higher at the moment, and obviously, if they are correct, then the Treasury forecasts of the fiscal position are either prudent or pessimistic, depending how you want to put it. What has been perhaps a bit more of a surprise, certainly to me, is that separately from this there does seem to have been considerable buoyancy in tax revenues and in making any forecast you have to make a judgment as to whether that sort of buoyancy is going to last and for how long. As one of the other witnesses mentioned, I would remind you that in 1996 there was concern the other way round about dwindling revenues on Value Added Tax and was this going to be a permanent feature of the economy once the tax base contracted? There are always uncertainties. The buoyancy that we have had in tax revenues seem to be attributed to self-assessment. The Government makes the reasonable assumption that the revenues have moved up to a new higher level, that the rate of growth is not going to continue. If there is further buoyancy then obviously the fiscal estimates will turn out to be even more pessimistic, but I think the Government is quite right not to make the assumption that revenues are going to become even more buoyant.

  24. Do you think the buoyancy is going to go on?
  (Mr Weale) I am persuaded that the higher share of revenues, income tax revenues in particular, in the economy should be assumed to continue in making forecasts, but certainly in making my own forecasts I would not predict the share of income tax revenues in the economy to be rising except in response to particular tax increases that a government might be introducing.

  25. That means you do think the buoyancy will go on?
  (Mr Weale) I think the degree of buoyancy which has been assumed in the projections here will continue but I would not make projections of greater buoyancy than those assumed here. On the other hand, for my best guess of the fiscal position I would assume a faster rate of growth of the economy than is assumed here.

  26. Professor Congdon, could I encourage you to start from here?
  (Professor Congdon) On this question that you were discussing with Martin Weale you could simply ask the Treasury witnesses when they come along, has the average error in the deficit forecast changed over the years? In fact, there is in the Red Book a statement that the average error in the forecasts of the public sector net borrowing figure has been one per cent at GDP. I know that ten, 20 years ago, the Treasury used to give figures on what the average error in the forecasting appeared to be, so it is not difficult to do. My guess is that the forecasting error has not changed very much. I agree with Martin again, that I think the immediate prospect for the economy is rather more buoyant than the Treasury has been saying—that is perhaps the rest of this year—but I am worried, as I have been saying, about 2002 and 2003. May I suggest that when this Committee meets in 2004 we may be asking, "why has the deficit been larger than expected?" These things just go through cycles.

  27. You were the person who commented to us this morning on the links between fiscal policy and monetary policy. If I have understood you correctly you were clearly of the view that the course the Chancellor is taking will make life more difficult for the Monetary Policy Committee in making their judgments. Could you explain why you think that and how you think their judgements will be affected by this Budget?
  (Professor Congdon) There is the impact on the Monetary Policy Committee, and there is the impact on monetary growth and monetary policy. They are slightly different subjects. On the Monetary Policy Committee, sure enough, they can see through this impact on the total inflation rate from changes in direct taxes. I have made that point; I will not make it any further. I just say that I think it is rather misleading for the Chancellor to have done this. The other subject is, I am afraid, rather complex. What happened last year was that the Government had this big surplus and so people paid over their taxes and telecom companies paid for their mobile phone licences. This reduced their bank deposits and meant that monetary growth was slower than otherwise it would have been. The stated policy in both the Red Book and the book published by the Debt Management Office implies that that policy of public sector transactions reducing bank deposits will not apply in the same way in the coming year. To that extent monetary growth will be higher. I appear to be one of the few people in the country to worry about this. I do worry about it. It is one reason why I expect that the economy will be rather more buoyant than it ought to be in 2001.

Mr Davey

  28. Can I just ask you about this point that we keep coming back to this morning about the impact of fiscal policy next year on the macro economy? You all seem to be of the view that in 2001-2002 fiscal policy will be easier than in 2000-2001, the Chancellor spending his war chest. There is a fair degree of unanimity on that. What there does not seem to be unanimity on is how significant this relaxation is. A one per cent figure has been bandied around; there seems to be some agreement on that but there does not seem to be a consistency from you on whether this really matters, whether this is going to make a huge difference. Some people are slightly aware that the economy is faster than the others and that this may be too expansionary, but it is all very at the margins, is it not? I am not getting a clear sense that this is going to destabilise the economy.
  (Professor Congdon) What everybody agrees is that we never want the economy to be back where it was in, say, 1973 or 1979 or 1990 when output was, say, four per cent above trend. We then had this ghastly experience of inflation rising and then a recession as well. At the moment the Treasury estimates that output is about half to one per cent above trend. What we are worried about is that the one per cent fiscal boost will push it more to, say, two or three per cent above trend and then there will be problems of adjustment thereafter. I think those worries are valid. It is understandable that there have been these tax cuts and spending increases with this vast surplus, but in terms of demand management it is not a move in the right direction.

  29. Can I ask Kate to comment?
  (Ms Barker) I am less worried about it than Tim. I absolutely agree that the figures pencilled in are around one per cent. I suppose I am less worried about them for several reasons. One is that in practice I suspect it will come in a little bit better, particularly because of the point I raised about government investment. I do not particularly want to argue this as I think it should not be the case that the Government misses its investment target but it is quite likely that it will. I am also a little bit less worried about it because I do have a view in that I suspect that the economy is slightly weaker but, as you rightly say, it is all rather much at the margin. I made particularly the point about the savings ratio. I do think that it is likely that household savings are going to rise perhaps a little bit more sharply this year even than the Government expects. It is not impossible to see that as being something that reasonably goes alongside the Government saving a little bit less. Yes, I do think it matters but I do not expect it to have the consequences that Tim is suggesting, taking the economy a long way away from trend, although I absolutely agree with him that it would be extremely undesirable if it did.
  (Mr Dicks) To put it in black and white terms, I would say that the Budget and the fiscal stance would rule out any further cuts in interest rates were it not for the global environment. The global environment is weakening and I think we are in for another bout of deflation on the global economy but that alone may enable the Bank of England to make further cuts in interest rates, but the Chancellor is not helping that out.

  30. Presumably the Chancellor might have looked at the international outlook when he set the Budget.
  (Mr Dicks) Yes, but he did not—he has added to what he did last November. There is a lot in the pipeline. The things in the US started since the pre-Budget report so there was a lot—

  31. Yes, but that was before the Budget. Can I look at the fiscal rules? There has been a little bit of talk about the fiscal rules today and I am losing a bit of clarity on the fiscal rules here. Just before the Budget ECOFIN rapped the Chancellor over the knuckles and said he was not going to meet the rules that are contained in the Stability and Growth Pact. Do you think that budgets are anything that would please ECOFIN, Martin?
  (Mr Weale) Could I explain on that that the point made by ECOFIN was the one I alluded to earlier, that the Stability and Growth Pact requires a balanced Budget but the Chancellor's policy of balancing the current account means that he is aiming to run a deficit no larger than the net investment that the economy is doing. The documents here show net investment rising to 1.8 per cent of GDP. The Chancellor is projecting a smaller deficit than that but it is nevertheless not the balanced budget that ECOFIN required. Because the Budget has consolidated the loosening up that was perhaps alluded to in the pre-Budget report and introduced extra spending, it has made that discrepancy bigger.

  32. So the Chancellor has ignored ECOFIN in your view?
  (Mr Weale) In my view, yes.

  33. Would everyone else agree with that?
  (Mr Dicks) And rightly so.
  (Ms Barker) Yes, and I would agree with what Geoffrey said, that he was absolutely right to do so.

  34. We have talked about his fiscal rules not really constraining at the moment. He has got large surpluses and Martin suggested that he should have some short term rule to complement these. Could I ask the others, do you think that there is room for a short term demand management fiscal rule, which was the way you described it? You do not want to answer the question, do you?
  (Professor Congdon) What you could have is something of the kind that the change in the cyclically adjusted public sector net borrowing figure needs to be calibrated to the output gap and should not be too large. Perhaps you can put together a rule of that sort. But I think it is very difficult to expect the Chancellor to behave so mechanically. It is just not realistic.

  35. Martin wants to come back.
  (Mr Weale) I would favour something perhaps vaguer than that, if one cannot have constant expected tax rates, that the fiscal policy should be set to meet the two rules and, where there is flexibility, fiscal policy should be set to work with the Bank of England in meeting the Government's inflation target.
  (Ms Barker) I personally very much doubt that there is a perfect set of rules to be had. I think the ones we have got certainly have some failings but they seem to me to be perfectly good rules and I would be reluctant to change them.


  36. It is better to have some rules than to have none anyway, is it not?
  (Ms Barker) It is better to have some rules if they are aimed at what I think is the fundamental aim of the Chancellor's rules, and they do seem to me to accord with that, which is to ensure that you do not end up with unsustainable fiscal policy. They usefully achieve that.

Mr Davey

  37. But, Martin, you even criticised that. You said you wanted some sort of fixed future tax rates.
  (Mr Weale) The fixed future tax rates would be fixed on a sustainable basis and in that sense, provided you started off with a reasonable level of debt and so on, they would be designed to ensure that you never deviated from them. What they would stop you doing was moving tax rates down one year and up another year. It would be a slightly different definition of sustainability, but the more important point is that although the fiscal rules are a useful constraint at the moment, where we have a large surplus, they are no guidance to the Budget in a particular year.

Mr Beard

  38. Martin Weale, the Treasury's forecast predicts that economy will grow at its assumed trend rate of growth to the year 2003. What does that imply for the position we are at on the trade cycle?
  (Mr Weale) The assumption which is shown is that we are slightly above the equilibrium level of output. If you look at page 163, that shows the Treasury's projection which shows the output gap narrowing gradually to close eventually by 2006. We know of course that the future will not turn out like that but is a view that output or demand at the moment is slightly above long run equilibrium.

  39. What risks do you suggest are consequent on that assumption?
  (Mr Weale) I think that one risk is that demand in the rest of the economy is too buoyant, that, as Professor Congdon has suggested, the output gap will not close. It will tend to increase and in the end we will find that boom and bust have come upon us. That is a very real risk. I think one also has to mention the risk in the other direction, that the situation in the world economy will worsen further, that the Government and the Bank of England together will find that they cannot maintain domestic demand without an unacceptably large balance of payments deficit, and so we will get in these terms a negative output gap, revenues will then be lower than the Chancellor expects at the moment and in 2004 we will be worrying about why the deficit is so large. I do think that the sort of balance between those risks is roughly equal and in that sense the Chancellor's projection is a reasonably sensible one.

  40. What would you say was the likely path of interest rates given these growth assumptions?
  (Mr Weale) I think that here we have to distinguish the short term from the medium term. I would agree with Mr Dicks that unless the world situation deteriorates then it would be a mistake to make further interest rate reductions. On the other hand one has to remember that the inflation rate is likely to fall not only below its target but also below the one and a half per cent lower limit of the inflation band, and in those circumstances the Monetary Policy Committee is going to have to prove deaf to the press in order to resist pressures to make at least one further reduction.

  41. Ms Barker, do you agree with the Treasury that continued momentum in United Kingdom domestic demand is expected fully to offset weaker trade prospects? Are there risks from the US slowdown being greater than the Treasury has already encapsulated in its forecasts?
  (Ms Barker) On the whole I do not disagree with the Treasury's position very radically, but I do think that it is implicit in what I have been saying earlier that the risks from the external side are rather greater. That, as Martin rightly said, will have the effect of making the trade deficit worse as well as domestic demand slower, so my view is that there is somewhat of a downside risk to growth. I do also dissent from the view that has been expressed that there is no further scope to cut interest rates. I think there is some scope to cut interest rates a little further, not, however, because I think in the short run inflation is going to fall below one and a half per cent, although of course I think it might, but because I believe that the outlook for inflation two years hence is more favourable than do my colleagues. I certainly agree with the view that if by serious and indirect tax cuts you got inflation below one and a half per cent, there is nothing else going on. It would be quite wrong to cut interest rates because of that.

  42. If the trade deficit did deteriorate would that become a very serious factor?
  (Ms Barker) To some extent I am already slightly concerned about the deterioration in the trade deficit that is pencilled in the Treasury's forecasts and has it rising to around two and a half per cent of GDP. I do feel some disquiet about that and it is of course a disquiet that the CBI has expressed for some time, that the prospects for the trade sector and investment in the trade sector tend to be quite discouraging. What that will mean longer term is that we reach a point where we have to start to correct that and come back to a more neutral position.

  43. The Treasury expect households to rebuild savings after 2001, causing consumer spending to slow down. If that does not happen what are the likely consequences going to be?
  (Ms Barker) Part of the reason why I am not so concerned about the fiscal changes that have been announced this time is that I believe the savings ratio is likely to rise from its present level in the coming year because of the strong wealth effects we have seen are likely to ease off or even to reverse. If we did not see any rise in the savings ratio which continued to be very low, that would of course mean that the Government was moving its position in a less favourable direction and the consumer sector was not changing at all. That of course would probably tend to imply that we would see an even wider trade deficit and the concerns about the longer term would be greater.

  Chairman: Thank you very much.

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