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banner Thursday, 2 November, 2000, 09:54 GMT
Brown's limited options
The key question: is the economy working at capacity?
The key question: is the economy working above capacity?
By BBC economics editor Peter Jay

It looks as though Chancellor Gordon Brown is going to find himself with a prospective budget surplus of around 2% of GDP, which means that he will be repaying debt - rather than borrowing - to the tune of about 15bn in the financial year ending next March.

Whatever the chancellor now believes he will be able to do in the March Budget, he does not want it to be discounted and devalued by being taken for granted for the next four months

That's big money. He could reverse the cumulative effects of the Thatcher government's decision to link the state pension to prices rather than to average earnings, for a mere 10bn.

It is even possible that by the time Mr Brown stands up deliver his Budget next March he will be reporting surpluses of up to 17bn in this year and of 24bn billion in 2001-02, although that is unlikely.

Room for manoeuvre?

But is the chancellor's room for manoeuvre quite as utopian as these numbers imply?

Almost certainly not. For a start his own fiscal plans, already announced, suggest that without any further action government borrowing will become positive again from 2002, as investment spending builds up.

If the economy is growing on trend, the present and prospective current budget surplus of 15bn a year and rising is excessive and, if uncorrected, will act as an unnecessary brake on future economic growth

However, more recent economic forecasts project a large current surplus.

More limiting for the chancellor is the issue of whether the economy is currently "on trend", growing at a rate which is not so fast as to generate inflation.

When the economy is operating below that level of demand, it is reasonable to accept a government deficit to compensate for the dip in activity.

But when the economy is operating above its capacity, it is desirable to run a budget surplus - and use it to repay debt - to take demand out of the economy.

Supply-side revolution?

Unfortunately no one can be sure whether the trend rate of growth has changed recently.

Most economists assume that the UK economy can only grow at around 2% - 2.5% on average each year without generating excessive inflation.

When Ken Clarke was chancellor he announced that he believed that the sustainable growth rate had risen to 2.5% per cent annually; but Gordon Brown, wishing to be cautious, reversed this to 2.25% when he took over at the Treasury.

If the more cautious number is correct, then the economy, which is set to grow this year by around 3%, may now be operating somewhat above capacity.

In that case inflation may tend to accelerate and the Bank of England may have to raise interest rates by another half percent or so over the next year or two.

It would also follow that the chancellor should not think of spending much of his surplus, preferring to repay debt and soak up the excess demand.

But if the more optimistic growth rate is correct, then the economy may well now be growing on trend.

In that event, the present and prospective current budget surplus of 15bn a year and rising is excessive and, if uncorrected, will act as an unnecessary brake on future economic growth.

Then there would be little or no economic logic in persisting with such a surplus indefinitely into the future.

The Treasury's director of macro-economic policy has already confirmed to the Treasury select committee that "there is no government intention to run up surpluses for ever".

Interest rate worries

If, however, the government decides it is sensible to spend the surplus, there is the question of how the Bank of England's independent monetary policy committee (MPC) will react.

In theory the MPC should not be concerned about a budget which reduces an excess fiscal surplus if it is done in an orderly way.

But what seems prudent to the chancellor may seem risky to the Bank of England - which may then decide to raise interest rates in compensation.

All of this argues for caution and a large margin for error.


Finally, there is politics.

The opposition's headline strategy is that taxes and the tax burden are too high and rising, and can be cut by many billions by a sufficiently determined Conservative government after the election.

A huge current surplus could be a political embarrassment if it appeared to justify Tory claims that taxes could be cut without squeezing popular spending plans for health, education and transport.

This argues for creative conservatism in the numbers which Mr Brown presents to Parliament on 8 November.

The smaller the surplus can be made to appear, the less ammunition is handed to his opponents - and the lower the demands of his Labour supporters for more spending when the chancellor presents his real Budget next March.

Whatever he now believes he will be able to do then, he does not want it to be discounted and devalued by being taken for granted for the next four months.

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See also:

09 Oct 00 | UK Politics
Brown 'listening' ahead of budget
14 Sep 00 | Business
Could the government cut fuel duty?
22 Mar 00 | Budget2000
Brown's Budget gamble
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