Speech by the Chancellor of the Exchequer, Rt Hon George Osborne MP, at the Lord Mayor’s dinner for bankers and merchants of the City of London
This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government
Speech by the Chancellor of the Exchequer.
[Check against delivery]
Lord Mayor, Ladies and Gentlemen.
I am honoured to be invited again to speak at this historic dinner, and follow in a long line of Chancellors who have done so.
Lord Mayor, you and I were reminded of that long line on Tuesday, when you generously hosted a dinner at Guildhall to celebrate the 400th anniversary of the creation of the Board of the Treasury.
And I might say that it is entirely typical that when the Treasury decides to throw a party, we get someone else to pay for it.
The Treasury Board was created in 1612 to bring discipline and control to the public finances.
At the time, the European economy was weak, the Kingdom of Spain was burdened with debt, and the excesses of the popular newssheets were giving the Government a headache.
Thankfully, Lord Mayor, we have no such concerns today.
To mark this 400th anniversary, we also got out of the vaults the fine, silver candleholders and inkwells commissioned for the Treasury in the seventeenth century – one of the few bits of precious metal that my department hasn’t sold off since.
It is a risky business getting the silverware out in front of my colleagues, as the minutes of the last Treasury Board meeting, held back in 1983 reveal.
The proceedings ran smoothly; all the Treasury silver has been returned despite the Prime Minister’s determination, before the intervention of a Treasury security guard, to carry off two candlesticks.
On this occasion at least, Lady Thatcher was foiled by the Treasury.
That didn’t happen often – she once famously declared
I am extraordinarily patient, provided I get my own way in the end.
Those of us looking for positive economic news around the world have had to be similarly patient over the last year.
The Government has sought to keep the British economy safe in the storm, while sharpening our competitive edge for the future.
And I congratulate the City for taking the same approach.
In the last year, while other Western financial centres have become less competitive, London has actually strengthened its position as number one in the global index.
In the last year, I have attended the opening of impressive new headquarters for international firms such as UBS and Blackrock.
In the last year key players in the insurance sector like AON and Lancashire have moved to London – a reminder of how important that sector is.
And in the last year the first renminbi bond to be issued outside Chinese sovereign territory was issued here in London – a project that you in the Corporation, I, and many in this room have worked hard to bring about.
Of course no amount of competitive edge can protect this country completely from the financial storm raging around us.
And it’s our response to this storm that I’d like to address tonight.
First the British Government’s macro-economic strategy and the thinking behind it.
And secondly, our position on the eurozone crisis: what needs to be done, what might actually happen, and how we see Britain’s interests.
The common theme is an underlying problem of excessive debt – banking debt, government debt and private sector debt.
And the common challenge is how to manage the difficult process of balance sheet repair and deleveraging in a way that creates the conditions for sustainable growth and new jobs.
If we lose sight of the central role of debt in this crisis we will come to the wrong conclusions about how to respond.
Of all the major economies Britain was one of the most extreme examples of the imbalances that contributed to the problems the world now faces.
We had among the most leveraged banks of any country, a house price boom as large as America’s or Spain’s, and higher levels of household debt than any other country in the world.
Having entered the crisis with the largest structural budget deficit in the G7, we exited with a budget deficit forecast to be the largest in the G20.
In short the UK economy had tested the limits of an unsustainable and unbalanced model of debt-fuelled growth, and was badly in need of a difficult but unavoidable rebalancing.
Mervyn, you have called the UK’s economic strategy a “textbook response” to this situation.
Let me explain why.
Theory and evidence suggest that tight fiscal policy and loose monetary policy is the right macroeconomic mix to help rebalance an economy in the state I’ve just described.
Maintaining low market interest rates is also crucial in an economy as indebted as the UK; it smoothes the process of deleveraging.
This Coalition Government acted swiftly on taking office, set out a credible and steady plan to reduce our country’s record deficit, and created an independent Office for Budget Responsibility to monitor it.
In the space of just two years, we have cut that deficit by a quarter.
The credibility of our strategy has been rewarded in the markets, and we are today benefitting from safe haven inflows despite our large deficit and huge banking system.
In May 2010, the UK’s cost of borrowing tracked Italy and Spain; today Spain’s borrowing costs hit a record 7%, and Italy is borrowing at more than 6%, while our ten year gilt rates are just 1.7%.
Of course low long-term interest rates are determined by several factors, including expectations about monetary policy, but it would be perverse to argue that the credibility of the UK’s fiscal consolidation has not been a crucial factor.
Indeed it is our fiscal credibility that has created the space for the Bank of England to undertake QE on a large scale.
It is one reason why the Bank remains of all the major central banks probably the least constrained by political pressure.
Fiscal consolidation and an activist monetary policy have been combined with fundamental long-term reform of our banking and regulatory system.
The Bank of England now has responsibility for macro-prudential regulation through the new independent Financial Policy Committee, and by the time we gather for this dinner next year it will have regained its role in prudential supervision it should never have lost.
We are also making far-reaching changes to the structure of our banking sector.
We’ve got to stop problems caused by risk-taking here in the City of London spilling onto our high streets and putting taxpayers’ money at risk.
Two years ago at this dinner I launched the Independent Commission on Banking, and Vince Cable and I asked Sir John Vickers to Chair it.
One year ago I said we would accept in principle its core recommendations.
Today, we publish a White Paper setting out how the Government plans to implement those recommendations in detail.
High-street banking will be ring-fenced so that taxpayers are better protected when things go wrong.
We will be able to bail in creditors when a bank fails rather than turning to the public purse.
But we will recognise the special position of UK banks with large overseas deposits, and will watch international developments before imposing a fixed leverage ratio.
I believe that we have found a workable way to solve what I called the “British dilemma” – protecting British taxpayers in a way that does not make the UK uncompetitive as a home of global banks.
We have also made our whole economy a place that better supports businesses, wealth creation and new jobs with necessary changes to the planning system, more pro-business employment law, more competition in our university sector, welfare changes, and above all, school reform.
None of these things have been easy.
All have been controversial.
All were opposed by all manner of pressure groups and Unions.
All are vital if this country is to have a dynamic future.
And while my recent Budget came in for some criticism down the road in Westminster, it was recognised here in the City of London and around the world for the lower rates of personal tax and corporate tax it brought.
As the President of the CBI put it, it was a Budget for business that sharpened our country’s competitive edge and that is what I intended.
Of course, the challenge that is made to our economic strategy rests its case on low growth over the last 18 months.
No one in Britain would like to see stronger growth more than me.
But our independent OBR, the IMF and others have identified three main reasons for why it has not happened:
- there is a larger than anticipated impact of our financial crisis and deleveraging on potential output;
- there has been the global commodity price shocks, exacerbated here by our depreciated exchange rate;
- and, of course, there is the ongoing uncertainty in the eurozone which is now acknowledged to be having an impact on growth and investment across the world, from the US to China.
But crucially there is very little evidence from the OBR’s forecasts to suggest that the impact of the fiscal consolidation on growth has been larger than they forecast two years ago.
Of course, there are those who argue we should not be reducing the deficit – we should be spending and borrowing even more.
But that argument ignores a crucial fact: inflation in the UK has been significantly above the Bank of England’s 2% target since the end of 2009.
That is due to a combination of commodity price shocks, the lagged effects of a lower exchange rate and a worsening underlying productivity performance, and it has very important implications for fiscal policy.
Looking backwards it means that over this period looser fiscal policy would almost certainly have been offset by tighter, or less loose, monetary policy.
The fiscal multiplier is already likely to be low in an economy as open as the UK; an offsetting impact from tighter monetary policy would make it lower still.
In other words, much if not all of any gain from more deficit-financed spending would have been lost through higher imports and tighter monetary conditions.
Looking forwards, it is very hard to argue that monetary policy – in all its forms – has run out of road.
So the same argument applies for the future as for our recent past.
This suggests that any supposed gains from looser fiscal policy over the last couple of years or in the future are much more questionable than its proponents admit to.
The flipside of the argument is the cost and risk of discretionary fiscal loosening.
The costs are real and significant.
Our gross debt is already forecast to peak above 90% of GDP, a level above which the evidence suggests higher debt tends to reduce growth.
And the situation in several European countries today provides an example of how high levels of gross debt can themselves leave a country vulnerable to unstable market dynamics.
We can see across the eurozone that rising market interest rates and market instability are catastrophic for the process of recovery.
These risks are very real, not imaginary.
Consolidation is politically painful – I know that better than anyone.
So promises of consolidation tomorrow are not credible.
Some point to the United States and say they have pursued a different path – although I note we have the same unemployment rate.
And when evaluating the risks it is also important to bear in mind some important differences between the UK and the US.
As we see all too clearly elsewhere, a banking sector balance sheet worth 500% of GDP – compared to just one fifth of that in the US - creates the very real risk of a destructive negative feedback loop between the sovereign and the financial sector.
And sterling doesn’t enjoy the dollar’s status as the global reserve currency, which means the UK is much more exposed to market sentiment than the US.
Those who argue that countries with their own central banks don’t need to worry about market risk are forgetting the lessons of history.
Many countries with their own central banks have needed IMF bailouts – including our own country in 1976.
My conclusion from all this is that the balance of risks in the UK argues strongly in favour of credible deficit reduction.
Amidst all the uncertainty, one thing is for sure: credibility is hard-won and easily lost, and losing it is extremely costly.
That is not an excuse for doing nothing in the face of slower growth.
Far from it: the credibility we have enables us to do a great deal more than some other countries at present.
We can allow the automatic stabilisers to operate freely and we have already used the flexibility in our fiscal targets to extend the timetable of consolidation.
We have made further permanent reductions in current spending to pay for temporary increases in high quality capital spending.
We are today investing more in building new road and new rail, including Crossrail here in this City, than at the height of the spending boom – because that is a use of taxpayers’ money that gives a real economic return.
We’ve introduced the biggest back to work programme in this country’s history, including our new Youth Contract to get more young people into work.
And we have used our balance sheet to support a large programme of credit easing for small businesses through our National Loan Guarantee Scheme
But we can do more, and I can tell you tonight we will.
The immediate priority is to counter the tightening of financial conditions and increase in bank funding costs caused by the crisis in the eurozone.
Supportive monetary and financial conditions are a core part of our strategy, so we must prevent an unplanned tightening undermining the recovery.
I see an important role here for the new Financial Policy Committee in ensuring that capital and liquidity regimes balance the need for strong banks with the need to avoid a pro-cyclical tightening of financial conditions.
That’s what I meant last year when I said we are not seeking the stability of a graveyard.
Today, I can announce that the Government will amend the Financial Services Bill to give the FPC a secondary objective to support the economic policy of the Government.
I will make it a legal requirement for the FPC to report, for every action it takes, how that action is compatible with economic growth as well as stability.
That is for the future.
But in a period of financial stress, when private sector confidence is low, we can also use the credibility of the public sector balance sheet to support investment and the flow of credit now.
A lack of credit is damaging businesses and costing jobs.
The Government and the Bank of England have been working closely together to develop the right response.
I can tell you today that the Governor and I will take coordinated action on liquidity and on funding for new bank lending in order to inject new confidence into our financial system and support the flow of credit to where it is needed in the real economy.
We are not powerless in the face of the eurozone debt storm.
Together we can deploy new firepower to defend our economy from the crisis on our doorstep.
Funding for lending to the family aspiring to own their home and the business that wants to expand.
Liquidity for our high street banks.
The Government - with the help of the Bank of England – will not stand on the sidelines and do nothing as the storm gathers.
We are rolling up our sleeves and doing everything possible to protect British families and firms.
I know that Mervyn will have more to say to you about this in a moment.
Credit is not the only area where we can use the global confidence in our balance sheet to boost private sector growth.
We are already taking action to support new house-building and infrastructure investment through government guarantees.
In the next month we will set out how we can do much more.
And we will build on our success in attracting UK pension funds and overseas sovereign wealth funds to invest with us in the overhaul of our country’s infrastructure.
Of course, one thing that I think we can all agree on is that a resolution of the eurozone crisis would do more than anything else to give the UK economy a boost.
This is the second topic that I want to touch on briefly this evening – and I expect it will be the main focus of discussions at the G20 Summit I’ll attend in Mexico on Monday.
I have argued for a year now that the eurozone need to follow the “remorseless logic” of monetary union” towards much greater fiscal integration.
Otherwise, in the absence of the flexible exchange rate and independent monetary policy that we enjoy in the UK, the economic and political strains of deleveraging and balance sheet repair in the eurozone periphery may prove unbearable.
The solution in the eurozone doesn’t have to be a full-blown United States of the Eurozone but if it is to be successful it is likely to include most of the mechanisms that make other currencies work in countries such as the UK and the US:
- more support from stronger economies to help weaker economies adjust;
- more pooling of resources, whether through common Eurobonds or some other mechanism;
- a shared backstop for the banking system to strengthen banks and protect depositors;
- and as a consequence, much closer collective oversight of fiscal and financial policy.
These political implications were the main reason why I and many others campaigned against UK membership of the euro.
The political paradox Europe faces right now is this: some or all of these things are needed for the existing countries in the eurozone to make their currency work, but it may take Greek exit to make it happen.
That is a decision for the eurozone and the Greek people.
One thing is for sure: if exit is the chosen route then the eurozone must have a very good plan in place to prevent contagion.
The worst case for everyone would be exit without a sufficiently ambitious response.
But carrying on with the current uncertainty and instability is not much better.
A time for decisions has come.
So what are the implications for the UK and for our financial services industry?
Many people such as me had doubts about the original euro project but we should all be clear that it is strongly in Britain’s interests for our biggest trading partners to succeed; the risks for our economy of a disorderly collapse of the euro are huge.
That means it’s not in our interests to stand in the way of the further integration amongst the eurozone countries that any successful solution will require.
That includes proposals for a banking union – in other words, a union that stands behind the stability of eurozone banks and their deposits in return for common financial supervision.
This is a natural consequence of a single currency – we have seen all too clearly how bank stability and sovereign stability are so closely linked within the eurozone.
Indeed, that is why the Lisbon Treaty explicitly provided for common supervision through the ECB in the future.
But a banking union is not a natural consequence of a single market.
The same level of integration and common supervision is not considered necessary in other areas of the single market like energy.
So we are clear that Britain will not take part in this banking union.
British taxpayers will not stand behind eurozone banks, and British voters want the British authorities to be in charge of supervising our own banks, especially in a crisis.
Of course, all these kinds of changes do pose significant challenges for us – without the right safeguards, further integration within the eurozone could significantly alter the structures and dynamics of the European Union.
Under new voting rules, the eurozone will have as a bloc an automatic majority for most decisions.
That’s why it’s entirely reasonable for us to seek safeguards that protect the interests of Britain and other non-eurozone countries in a changing EU.
We want to remain full and active members of the EU single market, which has huge benefits for our economy.
Indeed we want to deepen and enhance the single market.
But the rules that govern that single market must continue to be determined by all 27 members of the EU, and not just by the 17 members of the eurozone.
In other words, the argument for safeguards that we were making last year is becoming more relevant than ever.
And getting the right solutions for the financial services sector must be a vital part of that.
Lord Mayor, these are very difficult economic times – as difficult perhaps as any our country or our continent has faced outside of war.
In the eurozone, things could still get worse before they get better.
What we can do here in Britain is set a steady course.
We can get a grip of the public finances.
Lay the foundations of a fundamentally more competitive and sustainable economy.
We can provide new help for lending and liquidity.
Protect our taxpayers from lasting Eurozone entanglements that would cost us dearly.
And above all, we can and we will keep Britain safe in the storm.