Little room for manoeuvre in budget

April 21, 2009

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–Gerard Lyons is chief economist at Standard Chartered. The opinions expressed are his own. Lyons will also blog his post-budget thoughts on The Great Debate.–

The outcome of this financial crisis depends on the economic fundamentals, the policy response and confidence. Chancellor Alistair Darling presents this Budget in an environment where the fundamentals are poor, confidence has been shot to pieces and the credibility of policy and his ability to spend any more is being widely questioned.

There are three key areas to focus on in this Budget. First, the Chancellor’s economic assessment. Second, his fiscal sums and how he can afford any further help to the economy. Third, his longer-term ambitions, aimed at reducing the budget deficit without killing the recovery whilst winning over the electorate and the markets. It is often said bad things come in threes. On the eve of his Budget, Darling will know that only too well.

First, the economic outlook. The Treasury often views The City’s forecasts as being too pessimistic about growth and too optimistic on the budget deficit. This time, the market’s growth expectations are terrible, and rightly so. People and companies have cut spending agressively, and the economy looks like it will decline anywhere between 3 percent to 4 percent this year.

Last August, on the eve of the collapse of Lehmans we expected the economy to collapse 2 percent this year. At that time the consensus was expecting growth close to 1percent. Now the market has not only caught up with reality but is erring on the side of caution.

Despite recent talk of green shoots, the economy is still declining. By year-end we may have hit bottom, but in his Budget the Chancellor may have to make clear the recovery, when it comes, will be gradual and drawn out. To be sustained that recovery needs to be built less on debt, borrowing and housing. The problem, of course, is new measures may be announced that do little to ensure a balanced recovery.

Second, the budget numbers. Think of a number, double it, and guess again. Who knows what numbers are being thrown up for the budget deficit by the Treasury’s forecasts. A figure around 170 billon pounds is already in the market.

Frivolous spending in the good times led the UK to go into this recession with a large budget deficit. It has since deteriorated as the revenue base has collapsed and government spending risen. If people and firms are not spending, the government has to. If not, the situation will be worse. But this should have been from a position of strength. It wasn’t.

Thus the Chancellor has little, if any, room for fiscal manoeuvre. Yet, with the recession deep he will want to do more. Any measures need to be temporary and targeted, and signs are help to construction, housing and the car industry will be announced. All have a political impact and the economic benefit should be clear, helping limit the downside, but at a further fiscal cost.

Third, credibility and confidence. How can the Chancellor ensure the economic and financial reaction is favourable? Well, a realistic read of how bad the present situation is would be a start and then outlining a vision for the future. Whether the electorate believes he has that vision is one thing.

For the markets the Chancellor is, I am afraid to say, in a no-win situation. Damned if he does, damned if he doesn’t! Last autumn the Chancellor announced future tax hikes. He is being urged to do more of the same. He shouldn’t. The best way to reduce the future budget deficit is to slash public spending and to create the environment for sustained economic growth. Given these constraints, how the Budget is received in Threadneedle Street will be important.

There the Bank of England still has the need and the scope for further monetary stimulus. Despite some fears, inflation is not the problem, growth is, which is why the Chancellor wants to do even more in this Budget. If only his predecessor hadn’t spent all that money!

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