Duncan’s Economic Blog

Osborne’s Mandate: There is no flexibility

Posted in Uncategorized by duncanseconomicblog on September 23, 2011

In the past week both Nick Clegg and Vince Cable have admitted the obvious –Britain faces a demand shortage.

As I’ve argued previously they are quite rightBritain has both an immediate demand problem and long term supply side problem. An increase investment has the potential to help resolve both of these issues by increasing demand in the short run and addressing supply side issues in the medium term. The problem of course is that the private sector, stuck in a deleveraging, balance sheet recession is unwilling to invest.

Hence the recent talk (denied) of a £5bn investment led government stimulus.

Now I’d start by noting that £5bn is a mere drop in the ocean in terms of the UK macroeconomy – welcome but nothing to get excited about. The amount of investment needed is much higher and it cannot all come from a government stimulus anyway. This is why banking reform to ensure it supports the real economy and wider structural reforms to the UK economy are much needed (proper structural reforms that actually help – not a handful of enterprise zones and talk of cutting maternity pay!).  

But the talk of a £5bn stimulus (coupled with the FT’s revelations about a £12bn ‘black hole’ in the public finances) has led to a discussion on the nature of George Osborne’s fiscal mandate and the question of how much flexibility he has.

Both Vince Cable and Chris Huhne have emphasised that Osborne is targeting the structural deficit and so has room to allow the ‘automatic stabilisers to work’. I.e. if the economy slows further and tax revenues drop whilst welfare spending increases, Osborne will not have to bring in extra tightening to counter act this.

Huhne has gone further and argued that Osborne is targeting the ‘current structural deficit’ so could actually increase investment whilst still meeting his target.

Do these claims stack up?

Not really.

Osborne set out his formal mandate his Budget speech last year:

The formal mandate we set is that the structural current deficit should be in balance in the final year of the five-year forecast period, which is 2015-16 in this Budget.

This mandate is:

Structural – to give us flexibility to respond to external shocks;

Current – to protect the most productive public investment;

And credible – because the Office for Budget Responsibility, not the Chancellor, will decide on the output gap.

So far so good – he’s targetting the current structural deficit so (if the FT is wrong about the OBR’s likely downgrade to the output gap) then he would have room to both allow the automatic stabilisers to work and to increase investment.

But, but, but… Osborne went on to say something he may well regret:

In order to place our fiscal credibility beyond doubt, this mandate will be supplemented by a fixed target for debt, which in this Parliament is to ensure that debt is falling as a share ofGDP by 2015-16. (my emphasis)

It’s this fixed target for a falling debt to GDPratio by 2015/16 that causes the problems. The current OBR forecast (almost certain to be revised heavily in November) is that debt/GDP will peak at 70.9% in 2013/14, fall to 70.5% in 2014/15 and 69.1% in 2015/16. I.e. Osborne is on course to meet his target two years early but by the narrowest of margins. The downgrades this Autumn are likely to mean he is meeting his second target just on time and with no rrom to spare.

In other words Osborne has no room to for a discrectiobnary stimulus without breaching his mandate. There is even a chance that the automatic stabilisers may have to be scaled back if he is to meet his target.

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12 Responses

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  1. Dave Holden said, on September 23, 2011 at 11:19 am

    I agree with your general prognosis here. On Osborne, well they say he’s an incredibly astute politician it’s possible he may realise the positive politics of a well aimed stimulus out way the negatives politics on a little wiggling.

  2. Agog said, on September 23, 2011 at 11:33 am

    Curious about what you mean by ‘proper structural reforms’ Duncan…. Normally ‘structural reform’ is code for ‘making life tough for workers AFAICT.

    • duncanseconomicblog said, on September 23, 2011 at 11:34 am

      Yes – unfortunate that that’s what people ten to assume.

      I mean raising the wage share of GDP, rebalancing from speculation to real investment, reforming the UK property market, etc, etc…

  3. Agog said, on September 23, 2011 at 11:54 am

    With you.

  4. Slinky said, on September 23, 2011 at 12:19 pm

    Good post, and I agree on the likelihood of missing the debt target, but am I missing something? Yes, by targeting the current structural deficit there’s some implied scope for the govt to allow “automatic stabilisers” to work. But with growth almost certain to be weaker over the coming years than official forecasts, the bulk of the overall fiscal deficit almost certainly “structural” rather than “cyclical”, and every chance that the size of this “permanent” deficit will be scaled even higher when the OBR has to revise down its estimate of the output gap in future forecasts, doesn’t the fact that Osborne is targeting the structural deficit mean that his hands are tied even more, not less? That is, he can’t blame weak growth for missing his balanced structural budget target. Weak growth will just make it harder to bring about the planned improvement in the structural deficit. Given the large size of the structural deficit, and the prospect of it being revised even higher, isn’t it more likely he’ll have to introduce greater austerity, not less, in order to balance this part of the fiscal budget?

    Obviously the solution is for the OBR to just say instead there’s a massive output gap, and that the deficit is almost all cyclical…!!

  5. JakeS said, on September 24, 2011 at 8:29 am

    The amount of investment needed is much higher and it cannot all come from a government stimulus anyway.

    This is a statement of political preference, not of operational constraints: In extremis, a sovereign state can command the sum total of productive capacity within its borders – there is no output gap so large that the sovereign is incapable of closing it, given the will to deploy sufficient seigniorage to do so.

    But with growth almost certain to be weaker over the coming years than official forecasts, the bulk of the overall fiscal deficit almost certainly “structural” rather than “cyclical”,

    No, weak (real) growth should tend to reduce, not increase, the full-employment deficit. The full-employment deficit is based on the needs of the private sector to amortise investments (which is, ceteris paribus, increased by real growth and reduced by inflation) and to maintain the share of sovereign securities in the private sector’s portfolio. So while inflation has ambiguous effects on the necessary deficit, real growth will unambiguously increase it, unless private savings desires and portfolio preferences change simultaneously (and fairly radically).

    Of course, the “structural deficit” that the OBR computes is not the full-employment deficit. But that is a problem with the OBR, not with the above analysis.

    – Jake

  6. gastro george said, on September 24, 2011 at 12:31 pm

    To paraphrase Goering, “when I see somebody reaching for the structural deficit, I reach for my gun”.

  7. Gareth said, on September 29, 2011 at 1:19 pm

    “Osborne has no room to for a discretionary stimulus”

    If investment spending has a fiscal multiplier 1, extra deficit spending now would increase GDP faster than it increase debt, so the target of falling “debt/GDP” would be *helped* not hindered by extra spending.

    This is the whole point of Keynesian spending, right? So if you think the fiscal multiplier is < 1, why advocate for fiscal stimulus at all?

    • Gareth said, on September 29, 2011 at 1:21 pm

      Hmm, my greater-than sign got filtered. “If investment spending has a fiscal multiplier greater than 1″, that should read.

      • duncanseconomicblog said, on October 4, 2011 at 8:50 am

        Gareth,

        Sorry for the late reply.

        I, of course, accept this argument. The OBR, the guardian of the forecast, appears not to. And for Osborne – that’s what matters.

        • Gareth said, on October 4, 2011 at 10:17 am

          The OBR seem to use a multiplier of exactly 1 for capital spending (in their documents from 2010 anyway), even when taking into account the expected monetary policy response. On that basis, the government could deficit-finance more capital spending, and raise the level of NGDP – hopefully leading to higher real growth – yet keep debt/NGDP the same.

  8. Keith said, on October 2, 2011 at 3:53 pm

    I am amused by the use of the word “mandate”. No one coffered a mandate on the present Cabinet to do anything. They gave no intimation of these policies at the election; the Liberals opposed most of them at the time. The policy of the Cabinet has no connection with promoting economic prosperity but merely allowing more tax cuts and profiteering by the wealthy. All based on voodoo economic myths. This is an Anti democratic disgrace. Productivity growth will be lower not higher. As has proved to be the case when ever these policies have been applied.


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