Examination of witnesses (Questions 20
TUESDAY 13 MARCH 2001
DICKS and MR
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 increasesI think that was the term
people usedand, 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 prudentand 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
(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
(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
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 sayingthat is perhaps the rest
of this yearbut 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.
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 nothe 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
(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
(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.
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.
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
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
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
(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.