Britain Still Needs a Fiscal Reset
"The Chancellor is right to keep his powder dry" was George Osborne’s comment on the mini-budget presented this week by Philip Hammond, his successor at the head of the U.K. Treasury. That’s probably correct given the cloud of uncertainty the Brexit vote is casting over the economy. If he waits too long, however, Hammond risks missing an opportunity to deliver the much-needed fiscal reset he promised when he took charge earlier this year.
For now, Hammond can hide behind the gloomy projections being produced by the Office for Budget Responsibility, the independent group Osborne set up in 2010 to ensure Chancellors of the Exchequer didn’t get to grade their own homework. The OBR this week slashed its 2017 growth forecast to 1.4 percent from 2.2 percent. But that looks very much like a worst-case scenario.
By the time the Spring budget rolls around, Hammond will have a much clearer idea of whether Brexit will blow a hole in public finances worth 59 billion pounds ($69 billion). And provided the economy hasn't fallen off a cliff, he should take the lead in a much-needed shift from relying on central banks and quantitative easing to governments using their fiscal elbow-room to help resuscitate growth.
But for anyone anticipating a big fiscal boost, the following chart based on the past five Autumn statements on government budget plans makes for bleak reading:
Hammond did announce some new spending this week to fund what he called "the need for investment to drive productivity and fiscal headroom to support the economy through the transition." There's a new National Productivity Investment Fund with 23 billion pounds to spend in the next five years.
Even more significant, regions that have won the right to increased powers to tax and spend locally — so-called mayoral combined authorities — will be able to sell bonds to fund local investment programs:
The government will give mayoral combined authorities powers to borrow for their new functions, which will allow them to invest in economically productive infrastructure, subject to agreeing a borrowing cap with HM Treasury. The government will also consult on lending local authorities up to 1 billion pounds at a new local infrastructure rate of gilts plus 60 basis points for three years to support infrastructure projects that are high value for money.
Ignoring for now the admittedly tricky questions of what is “economically productive” or “high value for money,” this is a welcome development. It directly addresses what former London Mayor and now Foreign Secretary Boris Johnson called the “fiscally infantilized” over-centralization of public spending. And it implements a July 2014 proposal from Parliament's Communities and Local Government Committee, which argued that “greater local revenue streams would enable local authorities to borrow to invest and so increase their tax yield and reinvest in further schemes."
The construction of a U.K. municipal bond market would be a welcome development. A landmark court case in 1991 ruled that municipal authorities, in particular the London borough of Hammersmith and Fulham, acted unlawfully by speculating on interest-rate swaps in the 1980s. That has retarded capital market activity by local government for decades.
Even with the recent rise in government bond yields -- the 10-year gilt yields 1.4 percent, three times more than it did in August -- money is still ridiculously cheap. That's great news for mayors with projects to fund; their bond sales will be welcomed by yield-starved pension funds in search of both diversification and higher returns than government debt delivers.
Hammond is right to have abandoned the aim of achieving a budget surplus by 2020. As a result, the OBR calculates that its forecasts give him 27 billion pounds of spending leeway "in case the structural outlook is worse than we think or he wants to announce more giveaways." The next time the Chancellor delivers a budget to Parliament, he should be mindful that those low-growth forecasts risk becoming self-fulfilling prophecies if he doesn’t do his bit to stimulate the economy.
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