Examination of Witnesses (Questions 120
TUESDAY 23 APRIL 2002
120. The MPC will no doubt read what the independent
analysts make of it as well, and it looks like they might be faced
with contrary conclusions because two of the independent analysts
are telling us that there is a fiscal loosening of between 0.4
per cent and 0.7 per cent GDP?
(Mr O'Donnell) But you have to be careful what they
are saying because, for the MPC's purposes, they have already
factored in what was in the PBR. If those analysts are saying
that relative to the PBR they think there has been a loosening
then I would disagree, and what is relevant to the MPC is the
news in this Budget which is the change since the PBR. I would
be surprised if analysts saw that the change since the PBR is
a loosening because it is a tightening; maybe they have different
forecasts for the economy but, again, I would be surprised.
121. You said earlier you were expecting private
consumption to slow. Is part of the reason for that because you
are planning a slight fiscal tightening?
(Mr O'Donnell) A little bit, yes. I expect that when
there is talk in the newspapers about increases in taxes, people
may look at their consumption plans going forward. Also they will
take their overall debt levels into account and think carefully
about whether they want to carry on building up their debt in
the way they have been in the last couple of years. Overall they
will moderate their debt and they will be looking at what has
been happening to incomes going forward. This time last year we
were in a stage where there were very big bonuses paid out, and
that had quite a dramatic impact on average earnings. This year,
if you look at the average earnings figures, they are much lower
and a large proportion of that is bonuses, and that lower income
path is one reason why we expect consumption to be lower.
122. Was the MPC briefed about the Budget before
its April meeting?
(Mr O'Donnell) No, certainly not before its April
meeting, because there was such a long time between that meeting
and the Budget. Our intention is that, when they have an interest
rate decision coming up, we will brief them beforehand to let
them know but also as a courtesy we brief them before the Budget,
so this time round on the Monday before the Budget I gave them
a briefing on the overall macro forecast and the macro implications
of the Budget certainly, but we do not go into specific individual
measures; we give them the overall fiscal sign. The reason we
did not do it before the April meeting is that it was a long way
away and the Budget was not finalised then.
123. Clearing up this loosening/tightening point,
we have had evidence from the Institute of Fiscal Studies saying
that the Budget has a negligible impact on the fiscal stance in
2003-04 and 2004-05 but that the net effect of the Budget is to
loosen the fiscal stance by £9 billion in 2005-06 relative
to what it would have been had the Chancellor not introduced any
of the measures in the Red Book, and that this arises from an
£8 billion increase in taxes and a £17 billion increase
in spending. Is that right or wrong?
(Mr O'Donnell) The figures are all laid out there.
The change in the fiscal stance is there. You are talking now
about 2005-06. If you look again at table 2.8, this is what reconciles
the two. It makes it clear there is a fiscal tightening in 2002-03
and in 2003-04, a tiny one in 2004-050.1and then
2005-06, which is the figure you chose to highlight, it moves
to a plus 0.3. So that is the answer. That is a very long way
forward. These are based on forecasts a long way ahead
124. Mr O'Donnell, the year has been highlighted
by the Institute of Fiscal Studies and presumably they have done
that because you and the Chancellor have talked about negligible
impact and tightening and so on, but this figure of £9 billion
is a substantial loosening in 2005-06, yes or no?
(Mr O'Donnell) The reason we emphasise the earlier
ones is because they are much more certain and relevant to monetary
policy which looks two years ahead. They are not setting monetary
policy on the basis of that number and as the years unfold we
will be changing that number quite substantially, but certainly
it is there. It is a 0.3 per cent plus increase, most certainly,
in the cyclically adjusted public sector net borrowing requirement.
125. So that is a £9 billion loosening
in that year?
(Mr O'Donnell) I have not got the figure in my head
as to what 0.3 per cent is, but it is certainly 0.3 per cent of
GDP in cyclically adjusted terms.
126. Can you tell us what has happened to the
Government's public sector borrowing position since comparing
the Pre-Budget Report and the Budget figures?
(Mr O'Donnell) Certainly. Looking at annexe C, that
is probably the best place on public finances, for example, C1
on page 206 gives you net borrowing numbers and compares them
with the Budget and the Pre-Budget Report, and gives them in billions
and in per cents of GDP.
127. Would you agree, particularly for the further
out years, comparing the Budget with the Pre-Budget Report, there
is an increase in borrowing?
(Mr O'Donnell) There is an increase in borrowing because
we have upped the public sector net investment numbers. That is
certainly true. You have basically current surpluses much the
same so you are meeting the golden rule every year and over the
cycle, and what you have is an increase in our estimates public
sector net investment. We now expect PSNI to be around 2.1 per
cent of GDP so that is why you have slightly higher borrowing.
But it is a long way out and, again, I stress that this is subject
to forecasts that are going 4-5 years out. We talked at the start
about our forecasting performance being one year out, and you
need to bear in mind when you are doing these things a long way
out that they are dependent on forecasts that have high standard
128. Do you agree that those borrowing figures
would be substantially higher had you not increased the trend
rate of growth that you use in the public finance calculations?
(Mr O'Donnell) We were very explicit about precisely
what impact the change in trend growth had on the numbers.
129. It is quite large, is it not? In 2005-2006
and 2006-07, if you compare the Pre-Budget Report with the position
now and you extract out the growth factor, then you are talking
about underlying borrowing which is about £8 billion higher
in 2005-06, and something like £10 billion higher in 2006-07?
(Mr O'Donnell) The trend growth effect is about £1
billion a year, cumulative. You can look at that either way. Indeed,
a number of people, including the Commission, said to us that
using 2.25 per cent going forward, which is what we were doing,
was building in excessive caution and was making our numbers rather
difficult to interpret. We are trying for our economic forecast
to use central views about what is happening to trend growth and
then we build in the same degree of caution as we had before,
a quarter point, and use the lower figure of 2.5 to forecast forward.
130. You mention the Commission and you are
anticipating my next question, which you can probably guess: do
your projections of central government net borrowing comply with
the Stability and Growth Pact?
(Mr O'Donnell) They comply with what we regard as
a prudent interpretation of the Stability and Growth Pact, yes.
131. You mean a less prudent interpretation?
(Mr O'Donnell) No. A prudent one.
132. How can looser borrowing figures be more
prudent than the Growth and Stability Pact?
(Mr O'Donnell) Basically, even when you go to the
end of this period and even on cautious assumptions, the figure
that the Commission is worried about, and you may have remembered
the discussions with Germany about an early warning, was deficits
hitting 3 per cent of GDP. We are well away from thateven
on these assumptions.
133. But you agree that when the statement was
made about the UK's convergence position by Ecofin on 12 February
of this year, they did express their concerns about the lack of
convergence on the part of the UK with the Growth and Stability
Pact. They said in part that they were quite relaxed about that
because of the 2.25 growth assumption you would then use, but
you are now not using that any more and they said in their note,
however, in view of a sustained deficit of 1 per cent of GDP which
was then being protected it is now more like 1.5 per cent, based
on a very cautious growth assumption. It notes the requirements
of the Growth and Stability Pact that you should either be in
balance or surplus, and it urges you to be cautious about any
deterioration and preferably to come back towards what is supposed
to be the Growth and Stability Pact objective of either balance
or surplus. So the next time you get a note from these guys they
are not going to be very happy, are they, because since they gave
you this light slap on the wrist you have upwards revised your
growth forecast and your borrowing figures. So you are going to
get a bit of a ticking-off, are you not?
(Mr O'Donnell) I would be surprised. The whole point
of the Stability and Growth Pact is to ensure that countries have
sustainable fiscal policies. When you think about what determines
what is a sustainable fiscal policy, and when they wrote the Maastricht
Treaty, they were worried about countries with excessive debt
levels, and if you run big deficits you end up with big debt problems
because the debt is the stock equivalent of the flow which is
your deficit. When you look at the UK, throughout these figures
we have a net debt level of around 31 per cent of GDP by the end
of the periodamong the lowest in the EU. If you look at
our generational accounts, you find that because of our demographics
and our policies, our fiscal sustainability over the medium to
long term is much better than the vast number of EU countries,
so when they look at the sustainability issue I am sure they conclude
that the UK is one of the most fiscally sustainable positions
in the whole of the EU.
134. You are making a very good argument for
reforming the Growth and Stability Pact to take into account some
of the issues that you have just mentioned, but at the moment
the Growth and Stability Pact is not defined in the way you might
like it to be. The Government so far has argued it is taking a
prudent approach and therefore has been less prudent, but do you
think that is going to remain the Government's positionin
other words, you are going more or less to turn a blind eye to
the literal interpretation of the Growth and Stability Pactor
do you think that you will be able to achieve reform in Europe
which will mean you will get agreement of other members to a more
sensibly structured Growth and Stability Pact?
(Mr O'Donnell) I stress that what is literally written
into the treaty is about avoiding 3 per cent deficits, and there
is a question about precisely how one implements that. Certainly
our view is that, when implementing that, we should, of course,
stay away from 3 per cent deficitsthat is in the treatybut
implementation in terms of deficits should take account of things
like where your net debt levels are. Also, I think there is a
strong case, and the treaty refers to investment explicitly, for
a country like the UK that has a very low level of public sector
investment compared to other EU countries.
135. Are you in discussions with other EU members
over that type of redefinition?
(Mr O'Donnell) Yes. We have made these arguments to
other EU countries and the Commission and we will carry on.
136. Are you making progress?
(Mr O'Donnell) I think so. If you remember a year
ago we were at the point then where some of the discussion in
this Committee was about the difference between actual deficits
and cyclically adjusted deficits, and we stressed the need to
think about things in cyclically adjusted terms. Now, virtually
all the analysis is in cyclically adjusted terms, and that is
a big step forward. It mattered going backwards in that it mattered
that during a downturn you were allowed the automatic stabilisers,
but it matters going forward. One of the big mistakes in Europe,
when they had a period of relatively high growth, because they
looked at absolute numbers rather than cyclically adjusted numbers,
they did not have tight enough fiscal policies during that period
so it is quite important.
137. So there is going to be no criticism of
the Budget by Ecofin when they do the next report?
(Mr O'Donnell) That is for them to decide but certainly
I think the more we can get the discussion about the economic
principles and why you need a Stability and Growth Pact basically
about fiscal sustainability the more we will get into discussions
about debt, investment, and basically ensuring that you have a
sustainable path in terms of reasonable public services as well.
A number of other countries are quite sympathetic to that view.
138. Could you clarify why you make the decision
now to increase the trend rate of growth assumption by a quarter
(Mr O'Donnell) Sure. We look at the trend growth assumption
regularly. Now, we are in a situation where the Government Actuaries
Department had supplied some new population numbers, which they
did just after the PBR, and we are at a spending review time so
we are thinking over the medium term, three years out, what we
can afford for the economy to do. That depends in part on what
the trend growth numbers are. Given that we had new population
numbers and that we wanted to put a solid base for that spending
review period, we wanted to look at the degree of caution we were
building in by the assumptions we had made and the population
numbers and some analysis, that led us to look at the demographics,
the changing age cohortswe looked at the activity rates
in each age cohortand there were some views being put forward
about how hours worked might change, it seemed to us that we should
bring all this together, and also review whether there were grounds
for claiming an increase, being able to say on solid grounds that
productivity had gone up. We put all of that together and that
is why we reviewed trend growth now.
139. But you have told us now you are assuming
no growth in productivity?
(Mr O'Donnell) That is right. We looked at it with
a hope that we would be able to say that actually productivity
had picked up and all the rest of it. We think there are some
reasons to suppose it might have done but it is not there in the
figures yet, so we erred on the side of caution, as is appropriate,
and we did not change it.