Recession risk heightened by Budget cuts, say economists

12 Aug 10
Economic forecasts this week say that the fiscal tightening set out in the coalition government’s June Budget has increased the risk of a double-dip recession
By David Williams

12 August 2010

Economic forecasts this week say that the fiscal tightening set out in the coalition government’s June Budget has increased the risk of a double-dip recession.

Estimates published by the Bank ofEngland on August 11 predict lower growth and higher inflation for 2011. They came in a week when it emerged that the Ministry of Justice was preparing for a 22% overall reduction in expenditure.

Projections released in the Bank’s quarterlyInflation Report on August 11 show the UK’s recovery from recession is likely to stall during 2011 as heavy spending cuts take effect.

Although the Bank’s forecasts showed a spread of possibilities, the centre of the range is now for an annual gross domestic product growth rate of just under 3% in the first quarter of 2011. The equivalent figure in the bank’s previous report, published in May, was close to 4%. The estimates also showed there is now a greater likelihood of the economy tipping back into negative growth next year.

Economists said June’s emergency Budget was a major factor. Simon Kirby, research fellow at the National Institute forEconomic and Social Research, estimated the Budget would knock 0.4% off GDP growth in 2011.

‘The single stand-alone event that will change the forecast for next year is undeniably the Budget. There’s nothing else on that scale,’ he said.

John Van Reenen, director of Centre for Economic Performance at the London School of Economics, told Public Finance the government should reconsider its fiscal policy in the light of the new figures. ‘The planned spending cuts are draconian, so would play a part in the revision,’ he said. ‘When you think about the fragility of the economy, there’s a serious risk of going into a double-dip recession, and those risks seem to have increased.’

But some argue that the weak growth vindicates the government’s policy on spending cuts. Michael Ben-Gad, head of economics at City University London, said the bank was accepting that the UK’s economy was undergoing a permanent downward shift.

Mervyn King, governor of the Bank, warned of a ‘choppy recovery’, attributing the more pessimistic forecasts to a fall-off in confidence, a lack of available credit and the ‘faster fiscal consolidation’.

The Bank’s MonetaryPolicy Committee expects inflation to remain above 3% into 2011. This is higher than the May forecast, made before a VAT rise was announced in the June Budget, which predicted a quicker return to the 2% target rate.

Research economist Rowena Crawford, of the Institutefor Fiscal Studies, said that the revised figures were unlikely to adversely affect public budgets. The autumn’s Comprehensive Spending Review could be adjusted to meet the new inflation projections, she said.

The figures were released as a leaked memo said the MoJ would be expected to cut £2bn from its £9bn budget over the next CSR period. The department employs 80,000 staff and the Public and Commercial Services union warned that 15,000 jobs could be lost as a result.

However, the 22% cut is smaller than the average departmental reduction of 25% outlined in the Budget, and markedly lower than the 40% mooted more recently.

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