Turning The Tide

06/12/2013 at 3:57 pm

There are a number of notable points which could be made about the Chancellor’s Autumn Statement yesterday. The political as well as the economic mood has clearly moved in his favour. Some of the measures announced, like the establishment of a moving target for the state pension age, were substantial. And of course the Office for Budget Responsibility has revised its economic forecasts up, meaning that the forecast level of government indebtedness has come down.

It is not the first time that this has happened. At the time of the Autumn Statement in 2010 and of the 2012 Budget, OBR debt to GDP projections drifted ever-so-slightly lower, with the peak level of indebtedness on a Treaty basis coming down by 0.8% and 1.2% respectively – before shooting up again in subsequent reports. But the difference this time is much more material: back in March, debt to GDP was forecast to peak at 100.8% in fiscal 2015-16; now the peak is to reach “only” 94.7% in the same year.

The full text of the OBR’s Economic and fiscal outlook attributes the difference to higher nominal GDP and lower borrowing about equally over the two years 2014/15 – 2015/16. It is worth quoting the following directly from the text:

While most public discussion of economic forecasts focuses on real GDP, the key driver of our fiscal forecast is nominal GDP – the cash value of economic activity – and its composition. The level of nominal GDP is higher across the forecast period than in March. … Whole economy inflation – as measured by the GDP deflator – is little changed from March.

In recent years there has been some debate about the possibility that governments would try to inflate their way out of debt (e.g.). Some economists even advocated this as policy. Regular readers will know that the idea isn’t a serious one – and the UK’s new numbers give some proof of this. In debt terms, the tide might just have turned, and higher inflation has played no part in this projection.

What we can say is that a little growth goes a long way. While the forecast for peak debt to GDP has fallen by over 6%, the cumulative change in real GDP to 2015 since the OBR’s March forecast is only +1.3%. As well as growing the denominator of the debt / GDP calculation, higher growth also reduces planned expenditure and increases projected tax receipts, thereby causing the cash amount of borrowing to fall. For economies with uncomfortably high debt, a growth spurt is the best possible cure.

This week’s data from across the Atlantic is warmly encouraging in this regard. US GDP for the third quarter was revised up in the second estimate to 3.6%, right at the top of the forecast range and the highest rate for one and a half years; confidence has rebounded from the blip of the shutdown; and unemployment fell unexpectedly to 7%, its lowest level in five years. (It is interesting to observe that this is the level which, arriving in 2014, was supposed to see the end of the Fed’s QE3. The press conference at which this was announced panicked the markets. So far this afternoon, by contrast, the S&P 500 is up by almost 1%.) If this is all beginning to add up to a proper global recovery it will be the best possible news for indebted developed-world economies.

As always we need to be careful. Reducing borrowing over the medium term will require continued fiscal discipline, and to borrow one of the Chancellor’s phrases, it can be human nature to focus on “fixing the roof” only when we are being rained on from a great height. And we should not give him too much credit either: he boasted proudly that the budget deficit as a share of GDP is expected to have fallen by 11.1% over the nine years following 2009-10. Another way of putting it is that it will have taken nearly a decade of continued borrowing for the UK to have not quite balanced its books again. Back in 1993 on the other hand, when the deficit peaked at 7.9% of GDP, it took only seven years to bring it up to a surplus of 3.5%: a larger improvement of 11.4% in total.

Still, falling government indebtedness is good news, and long may it continue. With a strengthening and prolonged global recovery there is every reason to think that it will.

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