Examination of Witnesses (Questions 240
THURSDAY 6 DECEMBER 2001
240. May I welcome you to this macro-economic
section? I shall start with a general question to all of you.
Thereafter we are focusing questions on one speaker but if anybody
wants to come in on the question, so be it. Has the Treasury made
a full and fair assessment of the uncertainty surrounding the
global outlook when devising the PBR forecasts for the economy
and the public finances? Is the overall balance of risks to these
Treasury forecasts to the upside or the downside?
(Mr Walton) The Treasury forecasts are actually quite
similar to the recent forecasts the Monetary Policy Committee
made in the Inflation Report. They are broadly in line in that
sense. They are a bit more optimistic than our own forecasts,
but the important thing to remember is that the fiscal rules the
Government has are expressed over the entire economic cycle. If
it turns out to be the case that the economy over the next year
or so is weaker than the Treasury expects, as long as that is
a cyclical shortfall which you can recover in future years, then
it should not really change the Chancellor's assessment of what
he needs to do for taxes and spending. It is important to distinguish
that point about the medium term. As far as the world economy
itself is concerned, there is still quite a lot of uncertainty.
Financial markets are taking the view that we are pretty much
at the bottom and that they are beginning to anticipate that we
shall see quite a reasonable recovery in global activity. The
view of myself and my colleagues at Goldman Sachs is that it will
probably take a little bit longer for the world economy to see
a recovery and that the recovery when it comes may be a little
more subdued than financial markets are expecting. As a result,
we have slightly weaker growth forecasts. If you take it over
a run of years, over the next three or four years, the actual
average level of growth we expect in the UK is pretty much the
same as the Treasury expects, it is just that the timing is slightly
(Mr Dicks) There was a lot of comment at the time
on the Chancellor's forecasts. Next year is very difficult, very
uncertain, but there was particular comment on the strong growth
forecast for the year 2003. I do not have a lot of problem with
that. With the amount of policy stimulus, fiscal and monetary,
which is going on in the United States, in Europe and the United
Kingdom, I would guess that on a one to two-year timescale the
global economy will be moving ahead quite rapidly. We can argue
about how far it goes backwards in the present quarter and maybe
in the first half of next year, but on the medium-term timescale,
the idea that the economy is growing at three per cent or faster
than that, given that we are going to have a hiatus next year,
does not worry me at all.
(Mr Weale) The statistical answer to your question
on whether the Treasury has given a good assessment of the risks
must be no. Unlike the Bank of England and, I have to say, the
National Institute, they do not give us any indication of what
the probability of particular outcomes is. If they want to give
an indication of the risks the economy faces, then they ought
to have tables showing that in their forecast and I hope it is
an omission which they will remedy at some point in the not too
distant future. Moving on to the question on whether I have any
real difficulty with the Chancellor's forecasts, the answer has
to be no, basically because it is broadly similar to my own view
of the likely evolution of the economy. The rapid growth which
he is forecasting in 2003 is perhaps a bit more rapid than I am
looking for, but on the other hand we know forecasting at that
time horizon is uncertain and it is silly to get exercised about
a quarter of a percentage point, particularly when we are talking
about the year after next.
241. Do you think the Treasury is correct in
its assessment of where the economy is now relative to its trend?
(Mr Weale) The Treasury is excessively confident in
the way that it describes the trend and the idea of a clear trend.
As far as I could see, although quite a lot of assumptions have
been audited by the National Audit Office, the question of the
trend is not one which at least is listed as having been audited
and I think it should be examined in greater detail. If I was
constructing a prudent forecast, I would assume that there is
a trend rate of growth, an average rate of growth, but no reference
to trend level. I would say let us suppose that the economy continues
from where it is now and in some sense bygones are just bygones.
During a period of a boom you might say that would be too optimistic,
it would give a Panglossian view of the economy, but in constructing
a cautious estimate at a time of weak economic growth, it would
seem to be more prudent than what the Treasury has actually done
which is build a fairly strong cyclical recovery in revenues into
the economy in 2003-04 and then continuing into 2004-05. They
may be right, it may be that this cyclical recovery in revenues
does happen, but I should have thought they were excessively confident
242. So they are erring on the side of optimism
rather than being cautiously optimistic.
(Mr Weale) On this occasion they are erring on the
side of optimism and not discussing the possibility that the weakness
in tax revenues may be semi-permanent.
243. Taking the situation overall in 2002, do
you think the upside risks predominate or the downside risks predominate
out of the Treasury's forecasts?
(Mr Weale) I am now inclined to think that they are
fairly evenly balanced. I could see consumer spending growth being
stronger than they predict. They predict a level savings ratio.
If the interest rate stays at four per cent then I could see people
going out and borrowing even more. That is a factor which could
be quite powerful on the upside. Obviously world trade, the world
performance could be weaker than the Treasury is assuming and
we have what has become the perennial question of Government spending
and whether they actually spend as much as they say they are going
to. If you like, there is the world trade factor, there may be
more concerns in the business sector which may discourage investment
but offsetting those you have to say now that there is an upside
risk on consumption.
244. On Tuesday when Gus O'Donnell
was here he said that the Treasury's latest GDP growth forecasts
had a 40 per cent greater standard deviation than normal. Do you
think that the higher-than-normal risk around the growth forecasts
is fully captured in the Treasury's range of opportunities?
(Mr Weale) Given that he said that I should wonder
why the sort of range they published was similar to what we are
normally told. I may have missed the relevant points in the document,
but I must say I did not notice that in the document I read. It
is very helpful if the Treasury is saying things like that and
it would be even more helpful if the calculations were put in
the public domain.
245. Would you say that was another indication
that things were rather optimistic?
(Mr Weale) Not necessarily that they are optimistic
but if they think there is greater uncertainty than is usually
the case, then they should give us probability ranges so that
people can understand the way they see the risks.
246. How confident do you think we should be
that the global economy will show some signs of recovery in 2002?
(Mr Weale) Now I am hoist by my own petard. I ought
to be giving probabilities and I am afraid I am not going to.
It is right that the United States' economy will start to recover
early next year. Perhaps here I am a bit more optimistic than
David Walton. Looking at the growth rate from the first quarter
of next year, we may see moderately rapid growth in the United
States which of course is a powerful influence on the world, even
though the average for 2002 will not be much higher than for 2001.
I am moderately confident, but I am afraid not able to give any
probabilities or chances to it.
247. The UK economy faces entry to the global
slowdown with a current account deficit of about 1.5 per cent
of GDP. Do you agree with the Treasury's expectation of a deterioration
in the current account in 2002?
(Mr Weale) The current account is likely to deteriorate
for the obvious reason that if we are growing faster than the
rest of the world, then our imports will be rising faster than
our exports. One of the difficulties in analysing the current
account is the rather erratic behaviour of some of the invisible
components. They do mean that simply focusing on the conventional
balance for goods and services normally gives you an excessively
gloomy view of the overall current account but equally they do
make it rather difficult for a forecaster to forecast.
248. Will a weaker external position for the
United Kingdom automatically mean that sterling will fall?
(Mr Dicks) No, one certainly could not say that any
economic phenomenon has automatic consequences for exchange rates.
Exchange rates do have lives of their own and simply because the
external account is likely to weaken, I certainly would not say
that sterling is likely to fall.
249. We could not rely on exports taking over
if domestic demand started to fall.
(Mr Weale) If domestic demand started to fall, if
consumers went back to their savings habits of five years ago,
unlikely for the reasons I have given but if that happened, then
we certainly could not rely on being pulled out of a very slow
period of growth or a recession by export sales.
250. May I pursue the assumptions which are
underlying the forecasts a bit further? I am looking at Table
2.2 on page 21 of the report and at the same time Table A9 which
is on page 160. It seems to me that underlying the Chancellor's
fairly optimistic assumptions about keeping growth going, is a
belief that in 2002 growth is strongly supported by central government
consumption. As you can see on page 160 there is a 4¾ per
cent figure down for 2002, a very big figure against any of the
others in that line. That drops right back in 2003 to two per
cent but what then picks up the stimulus is export which shrivels
to almost no activity in 2002 but surges back to about seven per
cent in 2003. It is rather neat. It is almost Keynesianism to
perfection. It is a central government stimulus in the first of
these two years and that tails out as the world economy picks
up. Am I right in that general reading of what is underpinning
the Chancellor's assumption? If I am right, do you think those
are reasonable assumptions to make?
(Mr Weale) May I say to the first point yes, you are
and one can add to that that included in the investment figure
is substantial growth in Government investment. So altogether
in 2002 the Government is adding about 1.3 per cent of demand
to the overall growth of 2.3 per cent. It is one of the biggest
Keynesian exercises that has ever been tried in this country.
What is assumed in 2003 is in essence that world activity returns
to normal and at the moment that is a reasonable assumption.
251. Table 2.2 on the world economy shows world
trade picking up from 1¾ per cent 2002 to 7¾ per cent
the next year. Are there precedents for world trade recovering
(Mr Dicks) It was growing at a double digit rate last
252. I know it was, but are there precedents
for a recovery? I know the level has precedents. What I want to
know is whether there is a precedent for so rapid a pickup from
(Mr Dicks) Given the policy stimulus I would say yes.
Once things turn.
253. Has that been the case in the past?
(Mr Dicks) Yes. The history of economic forecasting
is that we always miss the speed of the upturn, we miss the speed
of the deceleration. Most forecasters tend to come back to something
approaching trend and we tend to lose those troughs and peaks
in the cycle and the speed at which we move up and down through
254. You are not concerned about the implied
rapidity of that recovery. It does not look odd.
(Mr Dicks) No. What I am concerned about and this
was the gist of the note I sent to you on Monday, is the forecast
for public spending. Martin has alluded to these forecasts already.
To summarise the note I sent you: why is it always jam tomorrow?
Every budget, the budget of 2000, the budget of 2001, the Chancellor
tells us he is going to increase the real volume of Government
consumption by four per cent. Last year the outturn was 1.5 per
cent. Undaunted he came up with 4 per cent in this year's budget;
according to the PBR it is going to be three per cent but the
average of the first three quarters is only 1¾ per cent.
Undaunted yet again next year it is 4¾ per cent. A legitimate
question of the Chancellor or of the Treasury is: why is it always
jam tomorrow? Why do they forecast these big increases in public
spending? They are always point forecasts, there is never an error
band about these because they are not subject to normal forecasting
error because they are plans, yet it never happens. I have offered
an explanation this year, which is that the private labour market
has been so buoyant that it has been impossible or very difficult
for the public sector to recruit teachers, doctors, nurses against
the competing claims of the private sector. That of course may
change inasmuch as the private sector is probably a net shedder
of labour going forward and the public sector will have a better
chance to recruit the key personnel the public spending plans
are based up. I should like to know whether that is the Treasury's
explanation for why they have not managed to increase Government
consumption. If you look at investment, it is even more pronounced.
In the budget they said that general Government investment this
year would rise 43.5 per cent. Now, six months later, 21.5 per
cent. How can you plan to do something at 43.5 per cent, something
you have control over yourselves, and come back six months later
and say you have done less than half of what you were going for?
255. Is this not a bit of the oil tanker scenario?
Government investment and consumption has been so tightly constrained
and borne down on for decades and now when you come along and
you push the tiller it actually takes a while for the system to
respond. Crudely, it is not used to spending, it is not used to
investing and perhaps the systems are not there and the people
with the skills to do it are not there. Eventually, if you just
keep on the pressure, maybe the thing will start to flow, then
your problem might be trying to rein it back in. It that not the
(Mr Dicks) Maybe, but it has not happened yet.
(Mr Walton) What this does show is that fiscal policy
is not a good instrument for fine-tuning the economy. More by
luck than by judgement we happen to have in place quite aggressive
fiscal plans which happen to be supporting the economy just when
it needs it. It is very difficult to know precisely whether you
are going to spend the amount you plan. Even though notionally
you have control over this you do not always spend what you intend.
It is also a lesson for other countries. The US now is debating
a very sizeable fiscal expansion which will not take effect probably
until the spring of next year at the earliest, just at the time
when the US economy is probably recovering. These numbers are
always going to be imprecise, but this is quite an object lesson
in the caution of using fiscal policy as a very strong tool for
fine-tuning the economy.
(Mr Weale) May I offer the antithesis of Mr Plaskitt's
view that, public investment having been so low for so long, you
might think it would be quite easy to identify the things which
needed doing and then get on with them.
Mr Plaskitt: I am not denying that for
one moment. What I am asking is whether, once you have identified
that, there are the people there who know how to set about doing
it? Are the systems in place which know how to channel the money
to those targets? It may be that they have not been there and
they have to be put back in place, a culture has to be changed
before you hit those targets with the money which is now there.
That is all I am saying.
256. David, I want to ask you about your very
interesting paper which you provided for us. There seem to be
two components of this: one, optimism on the public finances in
the short term and then somewhat deep pessimism in the medium
term. Turning to the first of those, you point out in your note
that the growth forecasts in the PBR were not changed a lot from
the last budget, yet the borrowing forecasts deteriorated quite
significantly and disproportionately. What do you think is behind
that and do you think it credible that the budget forecast for
this year and next year has come down so much?
(Mr Walton) Most of the deterioration in the Treasury
forecast is on tax receipts and that is coming through. We are
seeing tax receipts coming in at a much lower pace so far this
year than was expected at the time of the Budget and the Treasury's
forecast for this year seems quite reasonable for tax receipts.
Where they may find that the outturn is a little better this year
is that in recent years government departments have struggled
to spend the amount of money that has been allocated to them.
If you look at the running total for Government spending so far
this year, it is coming in rather lower. In other words, for the
Government's forecast to be hit implies quite a sharp acceleration
in the pace of public spending for the rest of this year. The
more worrying thing is this shortfall in tax receipts. At the
end of the day, on the spending side whether or not you spend
it this year or next year, once it is there as a firm commitment
presumably at some point the spend will take place. What is less
clear is whether or not you get the tax receipts back. If you
just look at the assumptions the Treasury has made for economic
growth, and in Table B7 they show what that should mean for tax
receipts, they basically say that for these very small changes
they have made to their economic growth forecast, the maximum
hit to tax receipts should be £2 billion in 2002-03 and then
it is essentially reversed again thereafter. Whereas essentially
they are expecting a £10 billion shortfall in tax receipts
but then they expect to get most of that back again by the end
of the period. That may happen, but equally in the past the Treasury
has been inclined, when tax receipts have come in more buoyantly
than expected, to build that into their base line going forward.
What they have not done this time round is build in the undershoot
in tax receipts going forward. In a sense they have been a little
less cautious in their projections for tax going forward than
in the past and if it turns out that these tax receipts do not
rebound then they could find themselves with rather less medium-term
comfort on the public finances than they thought.
257. Because you think they may undershoot a
bit on spending, you think they are going to be okay on their
public finance forecast for this year and that the public borrowing
will be slightly lower than expected and there may be a small
surplus. Then you are pretty dramatically gloomy about next year.
I think from your note what you are saying is that we are going
to have zero public borrowing more or less this year and then
we are going to have a deficit of about £20 billion next
year, which is a pretty dramatic shift, particularly given that
the Treasury is not all that pessimistic on growth, it is not
as though they are forecasting a recession. You pick out a number
of issues in your note, which you think may account for this.
One of them is that maybe they are not going to get back these
tax revenues they are not getting this year. You are also a bit
pessimistic about spending, that the forecasts are sensible in
relation to spending.
(Mr Walton) There are three things as far as our forecast
is concerned relative to the Treasury's. One is that we actually
expect growth to be a bit weaker both this year and next year,
so that cyclically reduces receipts next year and you get that
back in future years. So that is one reason for pessimism. The
second reason is that I am just a little bit more cautious about
whether you do get the bounce back in receipts that the Treasury
believes. On the corporation tax side in particular you could
quite easily get a situation where there is a further deterioration
in corporation tax revenues, given the downturn in profits which
has taken place. The third factor on spending is that to the extent
you do get an undershoot in spending this yearand I am
assuming about a £3 billion undershoot in spendingthen
under the Government's end-year flexibility scheme in principle
that £3 billion could be added to the existing plans for
next year. So you get additional borrowing from that source. To
the extent that the budget balance this year may be about £3
billion better just because public spending undershoots, then
it is £3 billion worse as that money gets spent next year.
258. You then have two other maybe slightly
longer-term areas for pessimism, firstly the technical point that
the new tax credits are not yet in the numbers. The second thing
is that you point out that the Government's medium-term assumption
for the growth of public spending is roughly the trend rate of
growth of the economy, whereas in fact that is immensely unlikely
if the Government is going to put more into health, education,
transport and defence spending is probably not going to go down.
That could also put quite an upward pressure on Government's borrowing
(Mr Walton) On the tax credit point the package for
pensioners is already costed and in the Government's projections.
Then there are these additional tax credits for families with
children, the childless families on low incomes and for research
and development. The Institute for Fiscal Studies would have a
better estimate of the cost but I would have thought they would
cost at least as much as the pensioner package, possibly slightly
more. Then the more fundamental point is this one about the long-term
trend in spending. Conventionally the Government is assuming that
beyond the current spending round, current departmental spending
rises by 2.5 per cent a year and annually managed expenditure
grows by 1.75 per cent a year. Current spending in total is growing
by no more than 2.25 per cent a year in the period after the end
of the current spending round runs out. If you look at what is
planned for spending now in the three years from 2000-01 through
to 2002-03, you are seeing current spending growth somewhere of
the order of 3.5 per cent per year in real terms. The very simple
point is what is more likely to be seen, a continuation of that
kind of growth which is planned for the current three-year period
or a reversion to a much more subdued rate of growth? Given the
aspirations on health and on education, it seems to me that it
is probably reasonable to make an assumption that public spending
is going to grow something like 3.25 per cent a year for current
spending. If that happens, it follows that the outlook for public
finances is going to be somewhat worse unless the Government is
prepared to raise taxes in some areas to meet that spending.
259. Since 1997 Government has been in a very
favourable position on the public finances and the surprises have
tended to be the positive side, borrowing lower, bigger surpluses,
war chests to spend and so forth. What you seem to be suggesting
is that in this Parliament and perhaps throughout this Parliament
the news on borrowing may disappoint and the Government may find
itself struggling to meet its borrowing targets as opposed to
wildly bettering them as it was in the last Parliament.
(Mr Walton) It can still go both ways. The Treasury
would say they are assuming quite cautious estimates for GDP growth,
if trend growth turns out to be a bit higher then you will get
additional tax revenue and so on. There are certainly arguments
which go the other way as well. To the extent that tax revenues
for the first time since this Government came to office are disappointing
and we never know fully why tax revenues come in to a greater
extent or to a lesser extent, but quite often when they do come
in one way or the other they tend to persist. To the extent that
tax revenues are disappointing at the moment, there is a reasonable
chance that could continue. To the extent that the Government
has promised additional tax credits, then that is using up a lot
of its room for manoeuvre within the existing spending framework.
The implication is that if they do want to continue a rate of
current spending similar to what we are seeing at the current
time, then there is not going to be that much room for manoeuvre
within the existing public finance projections to fund that, if
they want to continue to meet their fiscal rules. I am sure that
the fiscal rules are going to remain pretty paramount. That probably
means that if they do have strong spending aspirations then we
are going to have to look around for tax revenues to finance them.
4 Managing Director, Macroeconomic Policy & International
Finance, HM Treasury. Back