US closer to reforming banking

The United States moved closer to reforming the banking system yesterday when the final wording of the bill before Congress was agreed.  It goes someway towards restricting the range of activities banks can engage in, such as proprietary trading.  It also includes a new one-off levy on the banking system which is expected to raise $19bn.

While not perfect and not the full version of the Volcker Rule, this is a significant step in the right direction.  We should learn from it here in the UK.

Budget - a quick reaction

It's always a risk to give an instant reaction to a budget, so I have some sympathy with the various commentators who are required to say something before they have had the opportunity to actually read through the Treasury documents.  But here goes.

It is not possible to determine right away if the Chancellor has managed to convince the 'bond vigilante' demands for further retrenchment.  However, the net impact on the deficit this financial year is unchanged from the projection given before the budget by the Office for Budget Responsibilty (the two are not quite comparable) and its estimate of the deficit (once the spending cuts announced after the election are factored in) is unchanged after the budget.  The changes take effect in subsequent years.  So despite the rhetoric, there is not much of a change this year compared to Alistair Darling's plans, once the surprise improvement in public finances has been included.  Again it's worth repeating - the deficit last year (ie Labour's last tax year) was £23bn less than was predicted in December.  That puts some of the changes into context.

The VAT increase has caught the headlines of course.  But there are other moves that should be noted.  Benefits are now going to be increased in line with Consumer Price Index figures not the current Retail Price Index, which is higher.

I'm now writing a short piece for Progress, having a look too at what Labour should be saying in response.

Anticipating the budget

The first Budget of the Conservative/Liberal Coalition is not long away - at 3:30pm today.  The talk beforehand has been of cuts of course and there is a real risk that this new move across Europe towards austerity will plunge the world into a period of slower growth or worse - we have yet to escape repeating the 1930s (there was a recession in 1937 as governments tightened fiscal policy).

I suspect there might be a surprise in store.  Osborne and Cameron are fans of the Thatcher years.  Geoffery Howe's first budget hiked up VAT and took some bold action (which is not to say it was the right action - that debate is for another entry).  Osborne may look to surprise here and administer what he will believe is strong medicine early on in this government's term of office.

I am interested to see exactly how much in spending cuts Osborne announces that is in excess of what Labour had already planned.  Let's not forget Labour's plans removed last year's stimulus and projected tough spending cuts; tougher than were seen under Thatcher.  But Labour took the view that the recovery could be fragile in 2010/11.  To what extent will Osborne increase cuts this year?  And to what extent will he really be filling in the details of spending cuts that Labour (or any party) had yet to announce?

There are two types of spin around this Budget.  One is political - the ConLibs are telling the country we're facing hard times and it was all the fault of the other lot.  One problem with this has been that Osborne's own creation, the Office for Budget Responsibility (OBR) has in effect supported Alistair Darling's projections.  Indeed, while it assumed slower economic growth in future, it took a less prudent approach to estimating tax revenue and spending which helped lower its estimates of the deficit.  And we now have new figures for 2009/10: the Office for National Statistics now estimates that the deficit last fiscal year was £23bn lower than Darling had predicted in December.

The other type of spin is focused on financial markets.  Some investors want to see evidence of government resolve, so the government (with establishment support eg Bank of England) is talking austerity.  It seems both Treasury and Bank were particularly worried during the Greece fiscal crisis that markets might focus on the UK.

Indeed if this austerity move does not pay off, and if the economy slows down again (it's not really recovered that much yet though as a result of the last government's actions we might expect to see growth continue), it will not only be Cameron, Clegg, and Osborne who will be held responsible, but Bank of England Governor Mervyn King too.  The stakes are high.

So Darling was right...

Was that it?  The pre budget forecast of the new Office for Budget Responsibility was supposed to show things were much worse than the previous (Labour) government had led everyone to believe.  In fact, while it revises down forecasts for economic growth from next year (with a slight increase this year), it also revises down the annual deficit.

There is one key difference that has been highlighted.  This is that the estimate of the structural deficit (which remains through the cycle) has been revised up by the OBR, from 7.3% of GDP in 2010/11 in Alistair Darling's March budget to 8.0%.  However, this figure of 8.0% of GDP is merely Darling's forecast in December, which itself was down from his Budget 2009 figure of 8.9%.  By the time you get to 2014/15, the new OBR forecast is 2.8% of GDP, up from Darling's 2010 Budget forecast of 2.5% but down from his December forecast of 3.1%.

I've kept this next paragaph in but see my clarification below.

An interesting point is that there is no mention (that I can see) of the effect of the bank bailouts.  The March Budget had a deficit figure for 2009/10 of £155.9bn excluding including bank bailouts (£166.5bn including excluding them), rising to £157bn in 2010/11 and falling to £126bn in 2011/12.  Now look at the new OBR figures - for 2009/10 it has £156.1bn (which it states is a reduction of £10.4bn from the previous figure of £166.5bn).  For 2010/11 it forecasts a deficit of £155bn, with a forecast of £127bn for 2011/12.  Has there actually been any change from Darling's figures at all?  The OBR report does not mention the cost of the bank bailouts (that I have found).  These new forecasts either exclude the bank bailout costs (which the govt expects to get back) [actually the financial interventions have produced gains in 09/10] or they are an amazing coincidence - in which case the deficit excluding including bailouts must be even lower (though it's not quoted).  I've emailed the Treasury to ask for more information. But see my clarification below.

The real question?  Why are forecasts attracting so many headlines?  The margins of error are large (as the OBR illustrates with its fan chart forecasts based on probability they are correct).  Economic growth forecasts are being revised all the time and often quite substantially.  Estimates of the structural deficit vary a lot too.

The lower growth forecasts do highlight the risks of lower growth however.  Too aggressive action too soon and we risk even lower growth - and higher deficits.

Correction/clarification

My figures above are correct once I sort out my exclusions and inclusions and some more data sheds more light.  The 2009/10 deficit was revised in April to £145.4bn or £156.1bn excluding financial interventions.  This tallies with the OBR figure for 2009/10, which means the OBR is quoting ex financial intervention (ie the larger figure).  This does mean the deficit including financial interventions may be lower than the figures the OBR is quoting and it means the similarity in the numbers is a coincidence.  However, by the time we get to 2011/12, both the March Budget and the OBR are pretty much in the same place ie in March the deficit ex interventions in 2011/12 was forecast to be £131bn whereas the OBR forecasts £127bn.