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?
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.