Speech by the Chief Secretary to the Treasury.
It is a great privilege to address the largest private sector gathering of foreign exchange reserve and sovereign wealth fund managers in the world.
As the condition in the Eurozone continues to trouble, the critical importance of maintaining trust between Sovereign Governments and those who invest in them has arguably never been clearer.
Today I’d like to talk a little about how the United Kingdom government’s economic and fiscal strategy has secured that confidence, and how we propose to maintain it.
Overall our strategy is to achieve strong, sustainable, balanced growth that is more evenly shared across the country and between industries and that strategy has five elements:
- fiscal consolidation to restore the public finances to a sustainable path;
- monetary activism to support the recovery and increasing the availability of credit;
- financial sector reform to increase resilience and reduce risks; tax reform to improve our competitiveness; and
- a comprehensive package of structural reforms to promote sustainable growth.
The economic strategy of the UK Government reflects the extremely challenging position we inherited when we came to power in 2010.
The economy was characterised by severe imbalances and an unsustainable fiscal position - problems that we had to address.
In 2007, the UK financial system had become the most highly leveraged of any major economy. Our banks’ balance sheets were worth more than 5 times UK GDP.
Total household debt had risen by over 70 per cent in seven years to 170 per cent of income in 2007, accompanied by a housing boom similar in scale to that in the U.S. and in Spain.
The UK relied heavily on foreign finance. Our current account deficit was the third largest in the world in absolute terms.
And by 2009-10, public spending had reached almost 48 per cent of GDP.
Our over reliance on credit and the financial sector led to growing imbalances in the UK.
In the decade before we came to power, financial services had increased by 70 per cent as a proportion of GDP, while manufacturing had declined by a third.
Our position meant that when the global crisis hit, the UK was among the worst affected.
We experienced the second biggest recession of any major advanced economy.
And when this Government came to office, the UK was forecast to have the highest deficit in the G20 as a result.
Since we have come to power it has become clear that the lasting cost of the crisis was even worse than originally expected.
Our independent Office for Budget Responsibility estimates that the UK economy will be 11 per cent smaller by 2016 relative to the pre-crisis trend.
Two parties in the UK - the Conservatives and the Liberal Democrats -came together as the first British coalition government in modern peacetime to address these historic challenges. Coalition Government is unusual in the British context, but it has proved to be stable and decisive.
The scale of the problem demanded large scale reform of the UK’s economy and finances:
- fiscal consolidation, to regain control of Government finances and to create the space for an active monetary policy to deliver the support needed by the private sector;
- financial reform, to return stability and confidence to our banking sector and the wider economy; and
- structural reform, to promote a healthy, diverse, and sustainable economy.
These are all critical elements of the Government’s economic strategy.
However, it was clear from the moment we came into office, with the condition of the Eurozone already deteriorating, and with our Bond yields roughly equal to those of Spain and Italy, that fiscal reform was - and remains - the Government’s top priority.
So on entering office, we swiftly set out a credible fiscal consolidation plan to get our public finances back under control.
We put in place a new fiscal framework that will require debt to be falling as a percentage of GDP in 2015, and a fiscal mandate to eliminate the structural current deficit over 5 years.
And we reformed the UK’s fiscal institutions, creating the new Office for Budget Responsibility to shield economic and fiscal forecasts from Government interference.
In doing so, we re-established the credibility of our forecasts, as well as of our fiscal position.
Indeed, the creation of the OBR has attracted interest from many other countries as they look to strengthen the credibility of their institutional frameworks.
At every stage our approach has been sanctioned by theory and evidence - combining tight fiscal policy with loose monetary policy, and delivering the majority of the consolidation through spending reductions, rather than tax rises.
We have put in place fixed totals for managed public expenditure until 2015, so that by the end of the period nearly 80 per cent of the consolidation will be delivered by spending reductions.
Our approach was endorsed by the IMF, the OECD, and dozens of leading British Chief Executives.
A credible fiscal policy requires not just action to tackle immediate problems, which is in itself politically challenging, but also action to tackle medium and long term pressures too.
In common with other industrialised societies, demographic change in the UK society represents a huge sustainability challenge for the public finances.
The number of British people over 100 is expected to double in the next decade, and then double again the decade after.
And while improvements in longevity should clearly be welcomed, it will put a massive burden on the public services unless we adapt our policies accordingly; were we to do nothing, debt would exceed GDP by 2060.
So right now we are also taking difficult but necessary decisions to ensure that our finances stand on solid foundations - gradually increasing the State Pension Age to 67 in 2026, reforming public sector pensions, and reforming our health care system.
As the economic challenges we face reveal themselves to be even greater, the importance of following through on our strategy becomes all the more critical.
Credibility is hard-won, but easily lost, and losing it is something we can ill afford.
We have shown great commitment and progress so far:
- almost 40 per cent of the planned consolidation for the Spending Review period has been achieved;
- the structural deficit, excluding debt interest, has been halved over our two years in Government, to just 3.4 per cent of GDP; and
- the vast majority of tax consolidation is now in legislation.
All three major rating agencies rate the UK as triple-A. The Government’s clear and detailed fiscal consolidation strategy has gained credibility with markets.
While our consolidation plans are controversial with some sections of society, we need only look at the price being paid across the euro area’s periphery, where market credibility is lacking, to see that delaying consolidation only forces Governments to take even tougher action that is more painful for societies when it comes.
Though, as I said, fiscal consolidation is the Government’s number one priority, it is not the only part of our strategy.
But it is securing financial credibility that provides the space for other kinds of essential reform to promote a return to long-run, sustainable prosperity.
Our fiscal credibility has allowed the Bank of England to keep the Bank Rate lower than it would otherwise have been, and to deliver additional monetary stimulus through quantitative easing.
Fiscal responsibility has therefore been accompanied by additional monetary support for the private sector.
In so doing, we capitalise on a critical distinction between the Euro Area and the UK.
When we set out our fiscal plans, our independent Bank of England Monetary Policy Committee can factor them into its inflation forecasts and respond appropriately to increase its monetary stimulus, in contrast, monetary policy in the Eurozone cannot be tailored to the needs of a specific member state.
We are also taking steps to reform the British Banking sector to ensure we return stability to this sector and place it on a more sustainable footing.
We are improving our regulatory system, establishing:
- a Financial Policy Committee to improve macro-financial expertise;
- a specialist supervisor for firms that manage complex risks; and
- a new independent regulator on business conduct.
On Thursday, the Government will publish its White Paper setting out its final proposals for reforming the UK banking sector itself, based on the recommendations of the Independent Commission on Banking.
Looking to the UK economy beyond the financial sector, we have given a great deal of attention to addressing the structural imbalances in our economy, and encourage private industry to invest and expand in the UK.
We are ensuring our policy provides the right incentives to entrepreneurs, employees , and businesses:
- reducing our corporate tax rate to the lowest level in the G7;
- raising the threshold at which people pay income tax to increase the take home pay of workers in Britain; and
- reforming welfare, to encourage and reward work.
We have led a great drive to reduce regulatory burdens to make it easier to do business in the UK.
And we continue to upgrade our infrastructure, so that businesses have access to the communications and transport links they need to operate.
We are undertaking the biggest rail investment programme in our country in over 100 years; we are investing in superfast broadband and Wi-Fi connections for cities across the UK; and we have contributed £3 billion towards the capitalisation of a Green Investment Bank that will accelerate private investment in the UK’s Green economy.
And as well as supporting long term reform, we are ensuring that we support short term demand to keep the UK on track to recovery.
In our Autumn Statement last year, we allowed the automatic stabilisers to operate freely and used the flexibility of our fiscal mandate to extend the timetable of consolidation by a year.
Our fiscal credibility means we were able to use our flexibility in the fiscal mandate. It means we can pass on the benefits of low interest rates to businesses and families, though credit easing and mortgage support.
And it means we can offer guarantees to new infrastructure projects, driving down financing costs.
We are working now to see how we can go further in using the Government’s balance sheet to support growth through house-building, infrastructure investment and providing small businesses with credit.
These measures demonstrate that far from being in conflict with our commitment to growth and stability, fiscal discipline is utterly essential to it.
Our policies are providing the basis of long term sustainable growth across the UK, increasing our country’s capacity, and ensuring it remains firmly regarded as one of the best places to do business in the world.
Further, we have secured the UK’s economic credibility and won the confidence of our investors.
Net bond purchases from overseas investors have totalled £45 billion over the last 12 months, and the UK continues to benefit from strong structural demand from domestic pension funds and insurers.
UK government bond yields have fallen from being comparable with Spain and Italy in May 2010, to tracking Germany and the US - at record lows of almost 1.5 per cent in recent weeks.
The confidence we have secured also means that we can continue to issue debt at very long maturities.
The long average maturity of the UK debt stock is around 15 years - roughly double that of any other G7 country.
Of course, with one of the world’s most open economies, our success is dependent on what happens outside of the UK as much as what happens within it. Our recovery has been hit by repeated shocks - from the euro area; and from oil prices.
First, the euro area crisis has created instability and uncertainty, undermining confidence and feeding through to tighter credit conditions for households and firms. Considering trade alone, the UK is more than six times more exposed to the Euro Area than the US.
Second, the OBR considers the inflationary pressures from commodity price rises from the middle of 2010 to have been the main drag on UK growth over the past 18 months.
While inflation is now falling sharply, and is within one per cent of our target, oil prices clearly remain a key risk.
Third, the lasting impact of the financial crisis has left the economy significantly smaller than its pre-crisis trend, consistent with evidence from previous financial crises.
The combined effect of all these shocks means that our revenue last financial year was almost 17 per cent lower than forecasts made in 2008.
We always expected that growth would be choppy following the financial crisis.
The small fall in UK GDP in the last quarter of 2011 and the first quarter of 2012, reinforces the message that the UK cannot be immune to what is happening in the euro area.
Despite these challenges, all major economic forecasters agree that the recovery will gain strength this year and next, on the back of growth achieved last year.
And the Governor of the Bank of England has made clear that “the big picture remains one in which the economy gradually recovers.”
So while recognising conditions remain challenging, there is good reason for confidence.
Employment continues to rise; and inflation is returning towards target.
Since I have mentioned the issues faced by the Eurozone as the major risk factor for the UK, as well as the global economy, let me say something about the UK Government’s approach before I finish.
We have long been clear with our Euro Area partners on what needs to happen to build confidence:
- resolving the uncertainty about Greece;
- ring-fencing other vulnerable Eurozone States; and
- properly recapitalising Europe’s banks. In that context we welcome the action taken at the weekend to support Spanish banks.
Some progress has been made but major risks remain.
Whatever happens after the upcoming Greek elections, the euro area needs to do more if it is to provide a truly comprehensive solution and ensure its currency is to function properly.
The UK Government has set out three clear priorities to take that forward.
First, the core of the euro area, and its institutions - those countries in a stronger fiscal position - will need to recognise that they need to do more to support demand and share the burden of adjustment.
Second, all Eurozone states will need to strengthen fiscal integration and move towards greater collective support and responsibility. That includes serious consideration of Eurobonds.
And third, we need to address Europe’s growth challenge. Britain has long argued for a pro-business, pro-growth agenda. That means completing the single market, regulatory reform, and promoting trade, as a necessary counterpart to Member State level actions. We would be happy to consider proposals for a capital increase for the EIB on their merits, as well as other possible solutions, such as project bonds.
Much of what happens in response to the ongoing crisis will ultimately be a decision for Eurozone nations, but, with such a great interest in what happens in the rest of Europe, Britain will continue to play an active and engaged role in the debate.
While we undoubtedly still have great challenges ahead of us, I hope I have shown you today how we have adopted a comprehensive and credible economic strategy, where fiscal policy is set to restore sustainability to the public finances, underpinning monetary activism that supports the economy.
This approach is based on widely accepted views of the short-term impact fiscal policy has in an open economy like the UK, with an independent currency and national central bank.
It has secured the low interest rates that are vital, not just to reduce our costs of borrowing, but also to give us the flexibility we need to support growth and stabilise the economy in the face of shocks from outside.
That is not to say that things will be easy. Recovery will still be challenging; it will remain uneven and, by historical standards, subdued.
But we should be confident that our economy can rebalance and recover, aided by sound management of the public finances, and policy targeted at growth and sustainability.