Commentary – Fiscal Policy
UK government expenditure has generally hovered around 40% of GDP since the 1950s with government revenue generally being a little lower. The 1970s saw a rise in in the expenditure to GDP ratio and a less marked rise in the revenue to GDP ratio. Under the influence of the Thatcher government of the 1980s the government expenditure and revenue ratios generally declined. The government expenditure ratio then began to rise in the early 2000s. By the time the financial crisis hit, the government expenditure ratio was back to 40% but the revenue ratio remained historically low. As a consequence the Net Debt ratio, which had been falling since 1950 and had reached historically a very low level, began to rise gently from 2000.
The onset of the financial crisis saw a sharp drop in real government revenues and an initial rise in real expenditure leading to a sharp rise in the government’s budget deficit; furthermore, as part of its response, the UK government took on the debts of several financial institutions. This in turn led to a sharp rise in the Net Debt ratio, especially so if these latter debts are included. Excluding them, on the grounds that they are supposed to be temporary, the Net Debt ratio rose to levels which were common in the 1950s and 60s. Including them the ratio rose to levels seen in the 1940s.
The Coalition government formed in 2010 aimed to reduce the budget deficit and the Net Debt ratio. Their initial plan was to halt, and then reverse, the rise in the Net Debt ratio so that by 2013-14 the ratio (excluding the effects of the post-2007 financial intervention) would be 70% and beginning to fall. Consistent with this their aim was to reduce the cyclically-adjusted current budget deficit from 4.8% of GDP in 2010-11 to 0.7% of GDP by 2013-14 and then run a surplus. The primary weapon they planned to use to achieve these aims was a reduction in their expenditure as a percentage of GDP from around 47% to 42.2% by 2013-14 and to around 40% by 2015-16.
By these measures they hoped to restore confidence in the public finances and thereby encourage private sector spending, especially investment spending. In the event, the desired rise in private sector spending was slow to materialise and, faced with the possibility of a prolonged recession, the government significantly relaxed its original fiscal stance in 2012. For example the Cyclically-adjusted UK Current Budget Deficit as a % of GDP was allowed to rise to over 3% of GDP in 2012-13 against the 2010 planned value of just under 2%; and the value in 2014-15 was projected (in 2014) to be slightly under 3% (itself an increase on the 2013-14 value) against a 2010-planned value of a small surplus.
In the Conservative Government’s Budget of Summer 2015 it announced the aim of eliminating the cyclically-adjusted budget deficit by 2017-18 and then running surpluses of around 1 to 1.9% of GDP for the next two years. In its March 2016 Budget this was changed to a target of running a small surplus by 2019/20. The proposed change in the cyclically-adjusted budget deficit from 4.3% in 2015/5 to -0.5% of GDP represents a planned 5-year tightening of fiscal policy that is higher than the actual tightening achieved from 2009/10 to 2014/15, which was from 8.2% to 4.3% of GDP.
The planned turnaround in the budget deficit is primarily due to a fall in government expenditure from 40.8% of GDP to 37%. And this in turn is due to a plan to keep real current government expenditure more or less constant and so allowing it to fall as a percentage of GDP from 36.8% to 33.4%.
Following the onset of the 2007/8 financial crisis the fiscal stance of most countries became more expansionary. Partly this was automatic as output and hence tax revenue fell, but partly it was because governments reacted to the crisis with some degree of deliberate fiscal expansion. The combined effect was a general rise in Net Debt as a % of GDP. As output began to recover after 2009 government budget deficits began to fall, i.e. the stance of fiscal policy began automatically to tighten.
The Greek crisis in 2010 – triggered by the fear that Greek government debt was so large that Greece would not honour its obligations to owners of its debt – led many governments to tighten fiscal policy still further. The stated aim was to restore confidence in their own government debt. This tightening can been seen in the lowering of the cyclically adjusted indicators of the government deficits. This move towards ‘austerity’ was particularly noticeable in those countries which were members of the Euro and required financial help to avoid default on their debt, notably Portugal, Spain and Greece itself.
By 2014 Portugal and Greece had virtually eliminated their primary deficits and were projected to maintain that position. (Spain then still had a relatively small primary deficit). Despite this, because of its impact on GDP, ‘austerity’ has so far failed to lead to falls in Net Debt as a percentage of GDP.
Compared with these other countries the UK is projected by the IMF to have one of the tightest fiscal policies from 2016 to 2022 as measured by the projected fall in its cyclically-adjusted overall deficit as a % of GDP, but a comparatively modest fall in government expenditure as a % of GDP.