Chancellor to say that sustainable recovery is under way, but Ed Balls likely to counter that economy is still underperforming
Chancellor George Osborne will claim on Monday that critics of his economic policy have now decisively lost the argument and will say the economy has “turned a corner”, and that a sustainable recovery is under way. But he will insist that it is premature to consider any slowdown in his deficit reduction programme in the light of better economic forecasts, saying it is vital to stick to the course he has set.
“Even if the improving economic news eventually leads to an improvement in the fiscal outlook, the job will not be done,” he will say in a major speech aimed at setting the parameters of the 2015 election. “More tough choices will be required after the next election to find many billions of further savings.”
A bullish chancellor will claim that critics of his deficit reduction plans are at a loss to explain why the recovery is now taking place. He will point out that the spending cuts are at their deepest now owing to the backloading of the cuts programme.
He will point to evidence that shows in his view “the last few months have decisively ended [the] controversy” about fiscal policy – as those who advocate a so-called plan B cannot explain recent improvements in the economic data.
He will say that if he had heeded the advice of the shadow chancellor, Ed Balls, to spend and borrow more, it would have undermined the recovery. Instead he will claim he held his nerve, and that the economy is now recovering.
Balls is likely to counter that the economy has gone through three years of lost growth, and even now is underperforming. He may also suggest that the recovery is based on job insecurity, social division and falling living standards for most people.
Osborne is expected to address those arguments in part of his speech, saying that he will ensure the recovery rewards the deserving workforce, and not bankers. But he will insist: “The only sustainable path to prosperity is to reject the old quick fixes and stick to the course we have set.”
Osborne, seeking to avoid a premature triumphalist note, will say: “Britain is turning a corner. Of course, many risks remain. These are still the early stages of recovery. But we mustn’t go back to square one.” He will add that this is the only path to a lasting improvement in living standards.
He will admit there has been controversy as to whether GDP growth has been lower than he and the Office for Budget Responsibility (OBR) forecast. He will claim there have been two competing analyses: “The first is a simple – some would say simplistic – story that lays the blame mainly or sometimes entirely on fiscal consolidation by the government.”
These fiscalist advocates of plan B, Osborne says, claim that with interest rates at their lower bound, the fiscal multipliers – the impact of spending cuts and tax rises on output – have been much higher than anticipated, and the resulting impact of the consolidation on GDP growth far greater than forecast.
The counteranalysis advanced by supporters of Osborne’s plan A is that fiscal consolidation has not had any greater impact than originally allowed for in the OBR’s June 2010 forecasts.
Osborne will argue that plan A led to lower than expected growth not because of spending cuts, but mainly due to “external inflation shocks, the eurozone crisis and the ongoing impact of the financial crisis on financial conditions”.
The OBR agrees with the Treasury that the effect of multipliers on UK growth has not been bigger than its original estimates, he will point out. By contrast, he will say: “Proponents of the fiscalist story cannot explain why the UK recovery has strengthened rapidly over the last six months. The pace of fiscal consolidation has not changed, government spending cuts have continued as planned, and yet growth has accelerated and many of the leading economic indicators show activity rising faster than at any time since the 1990s.
“If the fiscal multipliers were much higher than the OBR estimates, as the fiscalist story requires, this should not be possible. Indeed, proponents of the fiscalist analysis predicted that stronger growth would only return if the government changed course and reduced the structural pace of consolidation”.
He will say growth is under way due the initial impact of the commodity price shock at the end of 2010 working its way through the economy: “The eurozone crisis that began in 2010 and intensified in the summer of 2011 has finally abated following the ECB’s decisive intervention last summer. That has removed the enormous tail risks that have been holding back investment and dampening consumption.
“The government’s continued fiscal credibility has allowed the UK authorities to pursue a strategy of monetary activism with schemes such as Funding for Lending that have supported a dramatic improvement in financial conditions.”
The chancellor will argue that the impact of cuts is likely to be relatively low in an open economy with a floating exchange rate and independent monetary policy. He will also assert that the UK’s pace of fiscal consolidation, at around 1% of GDP per annum, is line with the G7 and G20 average and the IMF’s guidance for developed economies.
If he had not shown the resolve to resist plan B, Osborne will claim, “the UK would have risked higher interest rates and becoming sucked into the eurozone sovereign debt crisis”. The economy would have been even more vulnerable had the euro crisis got even worse, leading to a bigger impact on living standards.
The main remaining external risks to recovery, he will claim, are “the slowdown in emerging markets, the possibility of further turbulence in the eurozone, and the risk that instability in the Middle East will push up oil prices”.
He will also insist that the recovery is not built on bad old ways of debt-fuelled, consumption-led growth, saying that figures like Ed Balls, after losing the wider fiscal argument, are now resorting to the claim that the Treasury is fuelling the wrong sort of growth.
He will claim that consumer spending accounted for less than half the rise in GDP over the first half of this year, while a rise in exports contributed much more.
Total private-sector debt has fallen by almost 40% of GDP since its peak in the first quarter of 2010. The ratio of household debt to incomes has fallen too, unwinding all of the increase seen during the credit boom of 2004 to 2008.
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