The government’s strategy is to combine deficit reduction with economic recovery, but at the moment we are not getting much of either. The chancellor confirmed that output is undershooting and government borrowing overshooting even the March Budget’s modest expectations.
Growth forecasts have been downgraded, the austerity programme extended to 2018 and the debt rule rolled on a year.
Technically the double-dip recession may have ended with the bounce-back in activity over the summer, but output in 2012 overall will be pretty much flat, against the March Budget forecast of 0.8% growth. The Office for Budget Responsibility’s new forecast for next year is an improvement, to about 1.2% - but still below its previous 2% projection.
Worse, the OBR does not expect output lost now to be made up further out. This output pessimism risks becoming self fulfilling as the corollary is even more growth-dampening austerity measures.
What is going on? The problem is demand – or rather the lack of it. Still in the shadow of the financial crisis, the private sector remains in balance sheet repair mode. Over-indebted consumers are saving rather than spending, and faced with huge uncertainty, businesses are sitting on cash rather than investing.
So public sector cutbacks are reinforcing private sector retrenchment in constraining growth. Meanwhile, the global slowdown, in particular recession in Europe, severely limits the scope for exports to come to the rescue.
The weak economy is frustrating the deficit reduction strategy as, ceteris paribus, it depresses tax revenues and increases welfare spending (although currently the latter effect is ameliorated by the surprisingly strong labour market). While the headline number for public borrowing falls this year thanks to special factors, thereafter it will be running higher than forecast in March.
Osborne’s “fiscal mandate”, viz to eliminate the structural current budget deficit over a five-year horizon, is a rolling target, allowing him to defer clawing back some of the overrun until 2017-18 when he has pencilled in yet more spending cuts.
However, the supplementary target – for public sector net debt to be falling as a percentage of GDP in 2015-16 – has proved harder to square. The OBR has judged that this deadline is unlikely to be hit and the chancellor has responded by rolling the target forward a year.
Given this financial background there was never going to be much room for manoeuvre. At least the chancellor did his best to avoid piling Pelion on Ossa, deferring new austerity measures and re-allocating limited resources, for example from current to capital spending, to get the biggest growth bang for his buck.
But there is no getting away from the fact that the fiscal squeeze is set to progressively tighten and the cupboard is pretty much bare.
This does not necessarily mean that we will get no growth again in 2013. For the personal sector, balance sheet repair is underway, employment is rising and the squeeze on real wages, which has been a major factor in holding back spending, is easing in the face of lower inflation.
However, “austerity” means what it says on the tin and getting even the 1% growth which the OBR has pencilled in next year may require further help from the Bank of England.
Andrew Smith, chief economist at KPMG in the UK