Vince Cable: Both right and wrong

In less than 24 hours we’ll know what the first estimate of GDP growth in the second quarter of 2011 is.

It looks set to be a poor number – showing either very weak growth or even an outright contraction.

To judge from the government’s reaction – they are worried. Whilst Osborne is once again talking of tax cuts – this time the 50p rate, Vince Cable has broken cover and plainly stated that demand is weak and that:

Clearly we haven’t got a strong recovery – that’s abundantly clear.

This has been ‘abundantly’ clear for some time.

But perhaps more worrying than Cable’s admission is the fact he doesn’t seem to grasp how Osborne’s fiscal targets work. Later in his FT interview :

he stresses the “flexibility” of the fiscal plan, which targets the underlying structural deficit. This means the chancellor does not have to cut even deeper – or raise taxes – if economic growth is more sluggish than expected and the deficit is falling less quickly than planned, he says.

Well – yes and no. Yes Osborne does target the structural deficit so in the event of a new downturn the automatic stabilisers (of more welfare spending and less tax revenues) could operate. But Osborne set himself a dual mandate.

As well as the target of eliminating the structural deficit by the end of the Parliament he is also targeting that debt should be falling (as a percentage of GDP) by 2015-16. As he reaffirmed in the Budget statement in March:

Our fiscal mandate is to achieve a cyclically-adjusted current balance by the end of the rolling five year forecast period – which is currently 2015-16.

We have supplemented that with a fixed target for debt: so that debt should be falling as a proportion of GDP by the year 2015-16 as well.

The latest (and now out of date) OBR forecasts show debt/GDP peaking at 70.9% in 2013/14 and falling to 70.5% in 2014/15 and 69.1% in 2015/16. In other words Osborne (on the OBR numbers) will hit his second fiscal target a year early but with very little room for error.

The OBR’s forecast of 1.7% growth in 2011 now looks like a potential error. It’s 2012 forecast of 2.5% is above the independent consensus of 2.1% for that year.

If growth misses the OBR forecast in both 2011 and 2012 then the second half of Osborne’s mandate would be under threat – he would have to either abandon it or push through more spending cuts and tax rises.

Vince Cable may well be right on his central point – that the recovery is very weak – but wrong on his more reassuring point that Osborne’s plans have the flexibility to deal with this.