Good morning, convener, and thank you for the invitation to speak to the committee. It is a great pleasure to be here—as always. The last time I joined you to discuss the economic and fiscal outlook was—perhaps fittingly—April fools day last year, following the coalition Government’s final budget. Since then, we have produced two further forecasts: the first alongside the post-election budget in July and the second alongside the spending review in November. To all intents and purposes, you can think of those as two halves of the same fiscal event. The Conservative Government has used them to depart significantly from the provisional tax and spending plans that they had agreed with the Liberal Democrats in coalition last March, setting out their own preferred strategy for the rest of the Parliament and beyond. In talking about what is in the latest forecast, it is perhaps helpful to contrast with the situation in March, so that we pull together the two elements of what the Government has done.
The first point to make is that neither the underlying forecast for the economy, nor the underlying forecast for the public finances, has changed a great deal over that period. Almost all the action of interest has been in the policy decisions that have been taken and the make-up of the remainder of the post-crisis fiscal repair job.
Back in March, we were predicting that the economy was pretty close to full capacity, that it would grow by about 2 to 2.5 per cent a year over the next five years and that inflation would move relatively slowly back to its 2 per cent target. Effectively, we made the same predictions in November and those are broadly in line with the average views of other forecasters. Those are our central forecasts. History suggests that reality will be less smooth than that, but we think that the fluctuations are as likely to be above those numbers as below them.
Most of the key uncertainties and questions around the economic forecast are pretty much the same as they were in March. When are we going to see a return to sustained robust growth in productivity and wages? How is the economy going to rebalance in response to the continuation of fiscal consolidation? How will the UK respond to global events, such as tighter monetary policy in the United States, lower growth in China and developments in Europe?
Reflecting the recent stability of the economic forecast, the changes in the public finances forecast over the past year have also been relatively small compared with those that we have made in earlier years. Following the autumn statement, many people latched on to the famous £27 billion—over the next five years—that we had apparently found down the back of the sofa. The biggest contributors to that aggregate improvement in the budget balance over the forecast period were a fall in the Government’s prospective debt interest payments, the knock-on effects of the recent strength of some tax receipts and some changes to the way in which we forecast VAT and national insurance contributions. Those positive developments were partly offset by the impact of lower share prices on tax revenues, as well as by judgments that we made on the outlook for spending on disability benefits and property transactions.
Unfortunately, £27 billion is not as much as it sounds. Over five years, it corresponds to an average downward revision to the budget deficit of about 0.25 per cent of gross domestic product. That is pretty small beer in an economy where the public sector is spending about 40 per cent of GDP and raising about 36 per cent of GDP in revenue, and where the average error in forecasting the budget deficit at an autumn statement, even over the remainder of the year that you are already in is twice as big, at 0.5 per cent of GDP. If we add in the changes to the forecast that we made in July, which went in the opposite direction, we have an even smaller underlying net improvement in the budget deficit since March, of closer to £10 billion or, cumulatively over five years, of about 0.1 per cent of GDP. Again, that excludes the impact of policy measures.
By way of comparison, if you look at the underlying changes that we have made to our budget deficit forecasts between previous March budgets and autumn statements, we had a deterioration of about 1.5 per cent of GDP in 2011, a deterioration of 1.25 per cent in 2012, an improvement of 0.75 per cent in 2013 and a deterioration of 0.25 per cent in 2014. The lesson from that experience is that what the sofa gives, the sofa can easily take away; the sums lost or gained have often been much larger than they were last November.
Confronted by our relatively modest changes to the underlying economic and fiscal forecast, what policy judgments has the chancellor taken, taking the budget and the autumn statement together? The key decision that he has made has been to reshape the remainder of the fiscal consolidation—the fiscal repair job—to rely less on cuts in public services spending and more on tax increases and welfare cuts than was implied by the coalition’s plans in March.
The tax increases and the welfare cuts build up gradually and less quickly than the chancellor said that he was going to aim for ahead of the election, so he has also decided to borrow more over the next three years to reduce the severest squeeze on public services spending in the middle years of the Parliament. He then aims for a slightly bigger surplus in the medium term. Combined with the changes to the underlying forecast, that leads him on course to achieve his objective of getting the budget back into surplus in 2019-20, with about £10 billion to spare. The performance of past official forecasts—ours and the Treasury’s—suggests that that corresponds to about a 55 per cent chance of achieving a surplus in that year, on current policy. It is by no means a done deal.
For public services, the two-stage loosening of the belt, as it were, in July and November means that the Government is now looking at a real cut of around £10 billion a year by 2019-20, which is much smaller than the £42 billion a year by 2018-19 that had been pencilled in by the coalition. That corresponds to a real cut in public services spending of about 1.1 per cent a year over this Parliament, compared with 1.6 a year over the previous one. That is smaller, but it is still quite a challenge. A lot of low-hanging fruit has already been plucked and the cuts are obviously much bigger than that average number in those areas of spending that are unprotected.
On the welfare spending side, the Government announced a significant package of welfare spending cuts or cuts in benefits and tax credits back in July, the proceeds of which the chancellor banked when setting his welfare cap—the cap on the cash spending on a large subset of welfare spending. However, by November that cap had already been breached, thanks in part to slower than expected progress on disability benefit reform and in part to the chancellor’s decision to reverse the major tax credit cuts that he announced in July. That is costly in the near term, but less so in the longer term, because by then most of the people who will be affected are expected to have moved on to the new universal credit. The universal credit was also reduced significantly in July, but those cuts were not reversed in November.
To wrap up, if you look at the evolution of the forecast since the end of the coalition, the underlying economic and fiscal picture has not changed very much. We expect the economy to grow, but at rates slower than you would expect in a typical economic recovery. We expect the budget to get back in modest surplus over the next five years, with the deficit having now more than halved from its postwar peak. However, as always there are lots of uncertainties in the underlying forecast, not least the outlook for productivity and wage growth and what that means for tax revenues.
It is also important to bear in mind that our forecasts are based on current policy; they are an assessment of the most likely outcome under current policy. Many other forecasters may think that policy might change. Some forecasters would look at the public services cuts and ask whether they can actually be delivered, some would look at the welfare savings and ask whether the Government can deliver the reforms logistically and the cuts politically, and some would say that if there are disappointments on either of those two fronts or on the underlying forecast, that might mean that the Government will rely more on tax increases or will look again at the ambition to be running sustained budget surpluses into the future. There are lots of uncertainties but, fortunately, those policy ones are outside our remit and we can leave them for other people to worry about.
I am happy to take questions on that.