Fiscal targets explained...

The latest forecast from the Office for Budget Responsiblity show the Coalition government on track to meet its moving target to eliminate the structural deficit on current spending within five years. But what do the financial figures look like and what do they mean?

The government is aiming to remove the 'Cyclically adjusted deficit on current budget' within five years (on a rolling basis). This is the deficit on government spending (but not investment, or capital, spending) that does not get eroded with economic growth. When an economy goes into recession, tas revenues go down (people out of work, having pay cuts or pay freezes) and spending goes up too (benefits to those out of work or on low incomes). This usually results in the government having to borrow each year, the cyclical deficit. When the economy grows again, tax revenues rise and people find work and have pay rises -and the government has more to spend elsewhere. The borrowing by government reduces and in a boom time, in theory, government can receive more in tax revenue than it spends.

However, governments often have deficits throughout the cycle.  Why is this? It's because they also borrow more money than will be received by taxes in an economic boom. This difference, between the cyclical deficit and the total deficit is known as the structural deficit, or the 'Cyclically adjusted deficit'. When we make sure there is no capital (investment) spending included we get the Cyclically adjusted deficit on current budget - the structual deficit.

Why cut the structural deficit? Well, as long as the government can fund its debt it can borrow for ever. Unlike households. However there are limits. If the debt becomes too large, investors may stop buying government debt (gilts). For the UK, investors might sell Sterling if they feared inflation. And the government's interest bill would grow, dominating the budget and putting the finances at risk of a rise in interest rates (which would increase the interest rate bill). The government can print money and use it to buy gilts (it did this during the crisis when it got the Bank of England to spend almost £375bn on gilts) but in some cases that can risk inflation and affect the value of Sterling against other countries (if people think the pound is worth less).

So central to showing you are credible on the economy and public finances is to show you mean business about getting structural borrowing down - or at least controlling it.

In the table below, from the OBR's latest Economic and FIscal Outlook, the government's 'Fiscal mandate' is in the third section down - I have highlighted it.. Here, it is expressed as a % of GDP. It starts at 2.6% of GDP, then goes up to 2.7%, before falling to be in surplus (a negative number) by 2017-18. Two things are going on here - overall the borrowing is going down mainly as spending is cut and GDP is growing.

At the bottom of the table we can see the actual amounts, in £ billion. Again, the structural deficit rises this year (2014-15) before falling - I've ringed round where it rises. The reason is that the OBR believes the economy is operating nearer full capacity than it thought previously. Taxes from income are well below its expectations but survey data suggests the economy doesnt' have that much spare capacity (the so-called output gap). The OBR has concluded that upside is more limited as far as tax receipts are concerned (at current tax rates) and therefore, compared to its March forecast, less of the deficit is cyclical and more is structural. Hence the figure rises.

The structural deficit then falls as spending cuts kick in further. In particular, the Treasury has told the OBR that although it doesn't have any specific plans beyond 2015-16, the OBR should assume that spending will fall at the same rate as in the current parliament (ie since 2010). We can see this in the highlighted (by me) figures at the top of the table. It's assumed tax receipts jump from 2015-16 but more importantly spending ('Total managed expenditure') falls further as a % of GDP. Those two moves combined produce a step change fall in borrowing as we can see down the table as we compare 2015-16 to 2016-17.

OBR EFO Dec 14 fiscal table

There are various reasons why, despite a higher structural deficit than previously thought, the OBR Outlook has helped George Osborne. A significant reason is that it assumes spending falls faster than previously forecast because the interest the government has to borrow on new debt will be much lower. The OBR has noted that gilt (government bond) yields have fallen this year - the government can borrow for 10 years for around 1.9% pa - and so has assumed that low rates continue for longer than expected. It has also corrected a £3.9bn (by 2018-19) error in its model. These changes add up year on year until the end result is an underlying downward revision to the spending forecast of almost £18bn in 2018-19.

How did we get such a large structural deficit (amount we have to borrow each year, don't forget)? The financial crisis hit the economy hard and we lost a lot of output compared to what would have happened if things had been fine. If the economy had carried on growing at its previous trend rate, we would have no, or only a small, structural deficit. So while the economy is believed to be growing at 3% this year, output (and all the taxes that would have brought) is well below the pre 2008 trend.

The huge increase in borrowing after the crisis was not mainly due to the government increasing spending by its departments in 2008-10. It was due to much lower taxes and higher benefit spending as a result of the banking disaster and consequent recession. But now the OBR (and most economists) is saying, much of that tax revenue will not be regained (or at least, the economy will never get back to the pre 08 trend level) so the spending that revenue was supposed to fund is now part of the structural deficit.

What if the government had not permitted borrowing to rise so sharply?  There would have been sharp spending cuts and tax rises at a time when people were losing their jobs and businesses were struggling to survive. It would have caused a Great Depression, an act of gross irresponsibility and callousness.

Stephen Beer, 12/12/2014

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Labour deficit cutting - the £50bn question

Labour says it will cut the current budget deficit by the end of the next parliament. This contrasts with the Tory plan to produce a surplus on all annual borrowing by 2018-19.  How much room will Labour have?

In the table below (table 4.47 from the Office for Budget Responsibility's Economic and Fiscal Outlook) we can see, according to OBR forecasts.

In the bottom section (ignore the highlights for now - see next post) we can see Public sector net borrowing (the amount borrowed each year) is forecast to be in surplus (ie -£4.0bn) by 2018-19. This is with government spending falling as a proportion of GDP to 1938 levels, the OBR says.

The line below shows the Current budget deficit. This is the amount borrowed each year to fund current government spending ie excluding capital, or investment, spending. This is forecast to be in surplus by £50bn by 2019-20.

Labour says it will have a surplus on this measure by 2019-20. Assume the surplus is very very slightly above zero ie really the Current budget deficit is in balance rather than in fact being a Current budget surplus of £50bn seen in the table...that's the amount of room Labour has to fund current spending compared with the OBR's forecast of the government's plans, in the last year of the parliament. This £50bn can be spread over the life of the parliament, limiting cuts compared with Tory-LibDem plans. Because under current plans the net borrowing surplus is £23.1bn in 2019-20, borrowing for investment is £26.9bn that year (50-23.1) assuming Labour sticks to current investment spending plans.

OBR EFO Dec 14 fiscal table

Stephen Beer, 11/12/2014

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Targets missed

As we look to the Autumn Statement and new official forecasts on Wednesday, it is worth having a look at where we got to in March this year, at the time of the Budget.

The Conservative-LibDem government had already failed significantly on deficit reduction compared with its original targets, as the snapshots below show.

From the March 2014 Economic and Fiscal Outlook (looking at the Cyclically-adjusted surplus on current budget and Net debt):

EFO March 14 titles

OBR EFO March 14 extract

The Cyclically adjusted surplus is supposed to be in balance on a five year rolling period. In 2010, that mean by 2015-16. It was forecast in June 2010 to be able to do this. However, the forecast at the Budget this year was substantially different - the government will miss that original forecast, though on a give year rolling basis (ie a moving target) it is on course (if a couple of years too late).

The supplementary target is for net debt as a % of GDP to be falling by the end of the parliament ie between 2014-15 and 2015-16. On the June 2010 forecast it does this, just.  The revised March 2014 forecast shows net debt to be much higher as a proportion of GDP and rising (it only just falls in 2016-17).

When the net debt figure, expressed above as a % of GDP, is shown in £bn terms, we can see by how much the original forecasts have been missed:

EFO March 14 titles

EFO 14 net debt bn

For the current fiscal year, that amounts to £71bn more debt than planned, and in the next year the government will have borrowed £123bn more than it planned in June 2010 when it accused Labour of fiscal prolifigacy.

Finally, a look at the net borrowing figure is worthwhile:

EFO March 14 titles

EFO 14 net borrowing bn

This year (2014-15), net borrowing by the government is expected to be £58bn more than planned in June 2010.

The figures out this week will be notable for the effect of an expected upward revision to GDP forecasts and a downward revision to tax receipts, but the number of moving parts means predicting what the OBR itself will predict is impossible with any precision.


Stephen Beer, 30/11/2014

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The decline in real incomes continues

New labour market data for the UK were released last week. The good news was that unemployment has fallen to 6%. The bad news is that people in work are, on average, still seeing their incomes overtaken by inflation. The chart below, from the Office for National Statistics, shows annual growth total pay, regular pay (ie excluding bonuses), and inflation since 2009 up to August this year (the inflation data is monthly, the wage data three month on three month).

ONS wages and prices to Aug 14


Stephen Beer, 19/10/2014

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Is there any strategic defence thinking going on?

The Guardian reports that the squadron of RAF Tornados in action over Iraq was due to be scrapped. But now the government has discovered that it needs them it is going to keep them after all. The replacement Typhoon fighters, designed for action against Soviet fighter jets rather than bombing, apparently have yet to be modified sufficiently to carry the bombs the Tornados are using.

Amazing. It would be laughable if the issue were not so serious.

Stephen Beer, 01/10/2014

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