FISCAL POLICY 2010Macroeconomics: Mo Tanweer; Harriet Thompson; Andrew Ellamsmohammed.tanweer@cantab.net

Key objectives of the topic

Fiscal policy What it is… why its important What are the current (UK) trends in fiscal variables What has been causing this Evaluate the problems of running fiscal deficits

You should understand:

Key terminology

What is “fiscal policy”?

Budget deficitDirect taxes vs Indirect taxes

PSBR vs PSNCR

Expansionary vsContractionary

fiscal policy

Cyclical vs Structural deficit

National Debt

Automatic stabilisers

Capital vs Current GGolden Rule

Budget 2009 (T)

Budget 2009 (G)

What is the relationship between this number and the national debt?

Budget position

£676 bn (G) - £498 bn (T) =

-£178 bn i.e. a budget deficit

What does this mean in context? £178 billion new borrowing this year works out as:

£487,671,000 a day in extra borrowing £20,319,600 an hour in extra borrowing

£338,660 a minute in extra borrowing

£5,643 a second in extra borrowing

Compared to revenues of…:

The average person earns about £25,000 per annum They get a personal tax allowance of £6,475 in 2009/10 Their taxable income is there £18,525

They will pay the BASIC INCOME TAX RATE of 20% on this That is £3,705

However they will also pay National Insurance at about 9.4%

That is another £1,741.35

Making their DIRECT TAX BILL = £5,146.35 in 2009/10

The Government is borrowing more in ONE second, than one (average) person’s entire direct tax bill for a year.

What has happened to the deficit?

Keynesian stimulus Bank bailouts

Unemployment

Recession

Corporation tax receiptsConsumption down

Financing two wars

Ratchet Effect

Net debtAt the end of

January 2010, net debt was £848.5

billion, equivalent to 59.5% of GDP. This is predicted to rise to almost 80%

of GDP by 2013/2014.

Print money to finance it?

Inflation… higher interest rates… crowding out

Don’t Panic

Explain the trend in the two variables between 2015-2018

Alistair Darling has already leaked that the March 2009 Budget GROWTH FORECASTS were overoptimistic at -3.75% for 2009 and revised it to -4.75% in this PBR

Evaluating a (£178bn) deficit

Intergenerational issues

Monetary policy weak

% of GDP (fiscal drag)

Breaches Golden Rule

Inflation

Crowding out (in?)

Fiscal expansion necessary

Can we finance it? (When QE ends?)

Breaches Sustainable Investment Rule

Credit ratings

Bond yields / exchange rates /equity markets /

Credibility

Economists’ letter

Ricardian Equivalence “Today’s borrowing is tomorrow’s taxes”.

Mervyn King;

Greece Mark II?

Compared to other countries?

Global coordinated fiscal expansion

Capital G?

The interest burden. What happens when

rates rise?

Euro membership?

International competitiveness

…as a % of GDP

Explain the gap between the red and blue lines

…structural deficit comparison:

Why has the deficit increased?

The primary balance is government net borrowing excluding interest payments on government liabilities. The tax burden is the ratio of tax receipts to GDP.

Structural balances among the EU member states

What does the UK spend comparatively more or less on than other EU members?

EU c

ompa

rison

s

…International comparison: PIIGScontagion

…Greece Mark II?

The UK could be the next Greece! Last month an OECD list of the countries with the most vulnerable public finances put Britain in fourth place behindIreland, Greece and Portugal - the 'PIIGS‘ because of their hefty government debt burdens and uncompetitive economies.

FISCAL RULES FRAMEWORK 1998(The Code for Fiscal Stability) Golden Rule

Over the economic cycle, the government will borrow only to invest and not to fund current government spending.

Sustainable Investment Rule Government net debt as a percentage of GDP will be

held over the economic cycle at a stable and prudent level (around 40% of GDP).

E.g. real terms p.a. increases in the NHS budget of 7.2% every year between 2002 and 2007

A Budget Deficit spent building the CAPITAL STOCK of the nation be that in PHYSICAL CAPITAL such as new infrastructure, new hospitals, new schools, better classrooms, more medical scanning equipment, more tanks… or in improving the HUMAN CAPITAL of the nation through better training and education will NOT be a problem. It will raise the capacity of our economy and subsequently bring in more tax revenue through the growth that it causes and may be more than self-financing.

Gordon Brown’s prudent rules broken

But “extraordinary times require extraordinary measures”…

The Temporary Operating Rule

“to set policies to improve the cyclically adjusted current budget each year once the economy has emerged from the downturn, so it reaches balance and debt is falling as a proportion of GDP once the global shocks have worked through the economy in full.”

TRANSLATED as: fiscal deficit to be back below 3% by 2015/16 National Debt to start falling as a proportion of GDP as

per the new Rule in 2015/16 Get the Queen to say it maybe they’ll believe her

…% change in recent years:

…as a % of real GDP

UK bondholders in 2008/09 according to Debt Management Office

The Maastricht criteria

In addition to these five self-imposed criteria, the UK would also have to meet the EU's economic convergence criteria ("Maastricht criteria") before being allowed to adopt the euro. These are:

1. Inflation rate

No more than 1.5 percentage points higher than the three lowest inflation member states of the EU.

2. Government finance (the Stability and Growth Pact)

Annual government deficit: The ratio of the annual government deficit to GDP must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.

Government debt: The ratio of national debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.

3. Exchange rate

Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devaluated its currency during the period.

4. Long-term interest rates

The nominal long-term interest rate must not be more than two percentage points higher than in the three lowest inflation member states.

The Maastricht criteriaHow is the UK doing if we update the charts below?

The Stability and Growth Pact

Given recent economic conditions, EU leaders have agreed that the flexibility provided for in the Stability and Growth Pact should be used, so that fiscal consolidation is only undertaken in line with economic recovery.

Under the excessive deficit procedure, to which 20 (of the 27) EU member states are now subject, the EU’s Economic and Financial Affairs Council has recommended that the UK brings its budget deficit below the 3% reference value by 2014-15.

•Is the UK on track to do this? UK SAYS NO!!•Will other EU countries achieve the target?

And if you are still worried…

There have already been political clashes over the speed of reduction of the budget deficit. Cameron

Government spending will have to grow less than the UK economy for the next 5-6 years. ALL PARTIES AGREE ON THIS! (but disagree on where and how fast to do it)

Tax revenues will have to rise faster than growth of the economy.