UK: The Budget Matters But the Bank Matters More

Wednesday’s budget provides an opportunity for the chancellor to set out a course for the economy and to send some important signals on tax, including the future of the 50p rate – if it has a future – and the level of corporation tax.

For George Osborne, it is an opportunity to clear up the tax confusion. In the absence of a clear lead from the chancellor, talk of mansion taxes and tycoon taxes has been free to take wing. If he revived William III’s window tax people might be surprised but not necessarily astonished.

I wrote on March 4 about how hard it has been to work out Osborne’s tax strategy. Paul Johnson, director of the Institute for Fiscal Studies, puts it better than I did. “Annual speculation in a vacuum is damaging and costly,” he wrote.

To paraphrase Oscar Wilde, for the IFS not to get your tax strategy smacks of carelessness. We need to know where the chancellor stands. This week is his opportunity.

Budgets are great theatre. They are important in setting the direction of taxation and the economy. This week should see the chancellor with the luxury (for him) of not having to revise down growth and revise up the borrowing numbers.

Though you can never say never with the Office for National Statistics, risks of a double-dip have eased. Osborne is on a firmer footing than a few months ago.

But businesses want a reason to be confident. Good budgets provide such reasons, for both firms and individuals. The EEF, the manufacturers’ organisation, says the clear targets set out in the government’s fiscal strategy should be matched by a growth plan with equally clear objectives.

Firms, it says, are fed up with talk of new taxes and the coalition debate over 50p. Osborne should be leading a growth drive with targets this parliament of increasing the number of firms bringing new products and services to market; attracting more globally-focused companies; lowering business costs and making the workforce more flexible and productive.

We shall see. It is fairly clear the budget will not have a big fiscal giveaway. With a deficit of roughly £120 billion, the ratings agencies hovering and the chancellor trying to get investors interested in 100-year gilts, this is a non-starter.

Indeed, much of the pre-budget debate has been stuck in a time warp. For many years leading up to the crisis it was understood that monetary policy, by which was meant merely changing interest rates, was the economic policy lever of choice.

Fiscal activism, cutting taxes or boosting spending to give the economy a short-term stimulus, had fallen into disuse. It had a brief revival in 2009, when the world was falling off a cliff. Since then governments, including America’s, have been implementing deficit cuts.

Pretty well all the stimulus action has been via monetary policy, with near-zero official interest rates, quantitative easing in Britain and America or the European Central Bank’s successful long-term refinancing operation (LTRO). Fiscal activism came and went very quickly though, as I say, nobody seems to have told those pushing for it to be used again this week.

A big fiscal giveaway would be £20 billion, roughly Alistair Darling’s 2009 stimulus package. But the Bank is in the middle of a monetary boost six times that, £125 billion, through quantitative easing (QE), on top of £200 billlion it did three years ago.

The two types of stimulus are not directly comparable. A fiscal giveway is for keeps, or at least until the governent reverses it, while the QE boost is intentionally temporary: at some stage all those gilts the Bank has purchased will be sold back.

How has the Bank been doing stimulating growth? The Times has run a series on Sir Mervyn King, including an interview in which the governor’s main defence was that history will be kind to him.

As far as monetary policy is concerned, the Bank was slow to cut when the crisis hit but acted quickly when the storm raged in 2008-9 and, for a conservative institution, embraced “unconventional” QE.

Some would say King is too gloomy – I know people who await his downbeat pronouncements with dread – but his supporters would say if ever there was a time you needed a dovish governor this was it.

What the Bank does matters a lot. Its senior officials are aware it has not yet responded adequately to criticism from pensioners and savers groups of the current round of QE.

Paul Tucker, King’s deputy and a strong candidate to succeed him, knows the Bank has to get supervision and regulation right, through its financial policy committee and prudential regulation authority. London’s role as a global financial centre means the Bank has to set an example to the world.

Perhaps the biggest economic challenge for the Bank, though, is how to return to normality for interest rates. Many see the Bank as so constrained by a weak economy and the fiscal tightening it will have no option buit to leave Bank rate at 0.5% and periodically pump in more QE, for years.

Some in the Bank are starting to think, however, of the exit strategy. Ben Broadbent, a member of the monetary policy committee, makes the sensible point that the financial crisis in Britain had little to do with the build up of household and corporate debt. It was mainly the banks, and in particular their overseas balance sheets.

Britain’s households, while they increased debt substantially, added to their ownership of financial assets at least as much. Household assets are several times liabilities (debt).

This means, he argues, the Bank will not have to tiptoe too much for fear of driving households and businesses over the edge. Most are strong enough to take higher rates, particularly if market conditions mean a lowering of margins between Bank rate and the rates people and firms actually pay, in contrast to the recent pattern.

Higher rates are usually reported as bad news. But when they do go up, even if not under the current governor (he has until mid-2013), it should be a sign that the long nightmare of the crisis is coming to an end.

The chancellor has a tough task this week combining good politics, good economics and some confidence-building but cheap measures. Most budgets, however, are soon forgotten. The Bank’s task in the coming months and years is arguably much harder and more important. Enjoy the budget, but remember the Bank.

My regular column is available to subscribers on This is an excerpt.

This post originally appeared at David Smith’s EconomicsUK and is posted with permission.