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UK Fiscal Policy at the end of 2015:  EREP review of 4th Quarter

UK Fiscal Policy at the end of 2015: EREP review of 4th Quarter

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This article is part of the EREP review of the UK economy for the 4th quarter of 2015. Complete review with sections from Jeremy Smith, Jo Michell, Mary Robertson, Graham Gudgin and Ken Coutts can be downloaded from the Prime/EREP website.

For almost two years each successive ONS quarterly report on the UK economy brings much the same news 1) the Treasury fails to achieve the target for the overall fiscal balance set way back in the summer of 2010; and 2) the recovery from the Great Financial Crisis, always predicted at last to be robust and sustainable, shows continued vulnerability.

Much like a fire started with damp wood, the recovery flickers, belches smoke, but fails to ignite.  The preliminary estimate of the Office of National Statistics for GDP came in at 0.5% higher than for the fourth quarter, an increase from 0.4% for quarters two and three (statistically non-significant and very much in the eye of the bean counters).  This modest expansion calculates to an annual increase of 1.9%, bringing the Osborne-managed economy to 6.6% higher than the pre-crisis peak of 2008Q1 (see further discussion of GDP performance by Graham Gudgin).

Weak fiscal performance both reflects and anticipates the sluggish output growth.  Actual economies grow in market (“current”) prices, with “real output” the result of a statistical adjustment.  The table below measures fiscal variables and GDP as they come to the Treasury, in market prices.  Statistical analysis strongly suggests that the revenue generated in the current quarter is closely linked to the GDP increase of the previous, reflecting in part the time gap between income generation and tax flows from PAYE employees.

I presented calculations in the EREP 2015 review of the economy implying that fiscal policy had a slightly negative impact over the 12 months December 2014 through November 2015.  The table below shows that the deflationary effect of fiscal policy for the third quarter of 2015 was minus £3.9 billion as revenues far exceeded increases in expenditure.  For the fourth quarter the negative fiscal impact is less even though expenditure tightened by considerably more, +0.7 billion increase compared to +2.2 billion for the third quarter.

 

Change in fiscal variables and GDP, 2015Q2-Q4

(Current pounds sterling)

 

Change in (£bn)

Time period:

2015Q2-3

2015Q3-4

Revenue

6.2

3.0

Expenditure

2.2

0.7

Net Fiscal Impact

-3.9

-2.3

GDP

+19.5

+17.1

% Change in GDP growth:

- 0.1

Source: ONS.

We should not attribute the smaller deflationary effect in the fourth quarter to the Chancellor momentarily moderating his austerity agenda.  While the lower quarterly change in public expenditure (£1.5 bn less) itself reduced aggregate demand, revenue generation fell by over half, by £3 bn compared to 6.2 bn for the previous quarter.  This drop of 3.2 bn in revenue generation resulted from the slightly slower current price GDP growth (minus 0.1 percentage points, in contrast to the +0.1 for price deflated GDP).

To put it simply, the smaller revenue increase reflects the UK tax structure operating as a counter-cyclical buffer to weakening aggregate demand.  On the surface, this appears a positive outcome – between the second and third quarters £100 of GDP generated £32 of revenue, falling to 17.7 for the last quarter (meaning a larger non-tax increase).  As a result GDP and household income increased more than would have been the case had the tax bite been larger.

On reflection we should curb our enthusiasm.  While pleased with the people-friendly operation of the automatic stabilizer to soften the blows from the Chancellor’s policies, it comes as part of an interactive process of slow output expansion and stagnant incomes for the vast majority of households.  Each quarter brings new constraints on fiscal expenditure; lower tax revenue reduces but does not negate, much less reverse, the impact of the constrained fiscal expenditure.

The UK economy is deep into a Tory-dug fiscal trap – each budget tightens the spending belt, which in the next quarter means that the resulting counter-cyclical fall in public revenue means the Chancellor fails to meet his self-imposed fiscal target.  That failure becomes a justification to reduce spending further.  The Chancellor has peddled this dysfunction process for over five years as a strategy of recovery.  This is not strategy, it is failure.

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