“Growth and the banks”
September 9th, 2011
Growth is the key to the UK government’s strategy. Let’s begin with a reminder of what the government forecast in its Budget Book in June 2010:
2010-11: 1.8%
2011-12: 2.4%
2012-13: 2.9%
2013-14: 2.8%
2014-15: 2.7%
Total: 13.24%
The March 2011 Budget book raised 2010-11 to 1.9%, cut 2011-12 to 1.8%, cut 2012-13 to 2.7%, and raised each of the last two years to 2.9%. This left total growth at 12.8%, with much more of the growth coming in the second half of the period. The loss of growth between Budgets One and Two would mean £6.5 billion less output and £2.5 billion less tax revenue in the fifth year, at current prices.
This week the Chancellor has confirmed he is likely to face a downwards revision to the growth forecasts for this year in the autumn. The OBR may well have to revise down next year as well, given the international background. I do not think the OBR could revise subsequent years up to make up for the loss. This forthcoming downwards revision might have to cut another 1% off the total, losing around £15 billion more output and £6 billion of tax revenue by year five. Even such a cut would still leave the growth rate from 2012-13 onwards at a high level for current conditions
As so much of the government’s deficit reduction strategy is predicated on extra tax revenues from growth, accelerating the current growth rate is the government’s overriding priority. In addition the government’s political strategy presumably relies on getting real incomes rising again after a nasty period of decline in recent years. This too requires a decent rate of growth in the next three years to bring it about. The government is currently reviewing its options to induce stronger growth.
It is against this background that the government will receive the Vickers Report in to banking. The press has trailed the Vickers proposals, in line with the interim report he published previously. The main point is likely to be a move towards ring fencing the utility retail banks from the investment banks in the large conglomerate banks. The argument appears to be over the timing of the introduction of such a segregation, and the terms of the ring fence. It is not thought likely that Vickers will seek divestment, but merely the imposition of internal barriers between the two parts of the bank. In the event of difficulties, it will cheaper and easier to prop up the utility retail bank.
The government has been saying it does not want to rush into this proposal as it does not wish to do anything to the banks that might delay recovery and hold up the supply of finance to new and growing business. Meanwhile the MPC is shifting from worry about inflation to worry about the slow rate of growth. As the regulators worry about what to do if banks return to excessive credit creation, the Bank starts to worry again about the lack of credit led growth in the economy. The Bank needs to put together the two sides of its work. It is both the prudential regulator-in-waiting for the banks, while at the same time needing to preside over an adequate monetary regime for low inflation and reasonable growth. The present situation sees frozen and cautious banks, low levels of money creation, and continuing fears over how to handle excess credit. It is not a winning mixture. We fear it means a longer period of slower growth. That in turn makes bringing the budget deficit down that much more difficult.
