The vast coverage of the Autumn Statement is out of all proportion to its macroeconomic significance.
The Chancellor and the Office for Budget Responsibility (OBR) have, in effect, traded assumptions. The OBR has cut its guess about potential output, implying that a larger proportion of the current deficit is structural. The Chancellor has retaliated by assuming that he will be able to cut public spending by 0.9% a year in real terms in 2015-16 and 2016-17, thereby putting the structural budget position back on track. The various measures announced in the Statement, while possibly of merit, are too small to have a major impact on the economic and fiscal outlook.
It should be stressed that the OBR’s negative reassessment of the fiscal position reflects a downgrade to its estimates of current and future potential output rather than worse-than-expected recent borrowing outturns. This downgrade may or may not be warranted but it is troubling that the fiscal framework pivots on a concept subject to huge empirical uncertainty.
Aside from the further spending cut from 2015-16, the various measures announced in the Statement are essentially self-financing. The main short-term expansionary measures are a reduced rise in fuel duties (costing £975 million in 2012-13), an increase in infrastructure spending (£760 million), additional funding for the Youth Contract (£365 million), small business rate relief (£210 million) and a cap on rail fares (£105 million). The infrastructure boost rises to £2.145 billion by 2014-15 but this is still only 0.1% of GDP. The Chancellor, of course, hopes to tap pension funds to finance a more ambitious programme but delivery is uncertain.
The cost of these measures is met by capping child and working tax credit (raising £1.24 billion in 2012-13), changing the tax treatment of asset-backed pension contributions (£450 million), cutting overseas aid (£380 million) and raising the bank levy (£280 million).
The Chancellor took credit for the low level of gilt yields in his speech but Bank of England data released today suggest that QE2 and capital flight from the Eurozone have been the key drivers: the Bank essentially monetized the budget deficit in October, with purchases of £16.9 billion versus DMO issuance of £17.0 billion, while foreign gilt-buying surged to £12.5 billion – the highest since April 2010.