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Osborne’s "flexibility" explained

6 June 2011

12:02 PM

6 June 2011

12:02 PM

So what does George Osborne mean by "flexibility"? Do we hear the quiet sound of a gear change, prior to a u-turn? No, I’m told, it’s Plan A all the way. And
here are the details.

The government’s five-year departmental budgets (the so-called DEL limits) are set in stone. They won’t change (in cash terms) until April 15, after which no figures have been set. If inflation
continues to be high, then this will exacerbate the real effect of the cuts (Osborne has already seen trouble caused by with this as inflation has turned the tiny NHS budget increase into a tiny NHS budget decrease). The OBR reckons it may deepen them from 13 per cent to 19 per cent."

What might change is the cost of debt and dole. This can’t be budgeted for: you never know how many folk will claim. But the greatest need for flexibility is on debt interest. About 22 per cent of
UK gilts are inflation-linked, so the taxpayer will have to shell out billions more as inflation continues to rampage. The Bank of England’s failure to control inflation has increased the cost of
repayments by more than £5bn over the last few months alone, according to the small print of the last budget. Coffee House was alone in reporting this.

This obviously affects the deficit. Money to pay for increasing debt has to come from somewhere. So total state spending will rise in cash terms because the departmental budgets are fixed. This
threatens to slow pace of deficit reduction.

So yes, Osborne needs flexibility. But his target is to eliminate the cyclically-adjusted "structural deficit", which is not the same as the deficit (see graph below). The structural
deficit is a matter of opinion: it’s the government’s underlying fiscal position. And the definition of underlying is very elastic: it’s all wound up with what one considers "trend
growth" to be. Brown had a genius for fiddling with these definitions: remember his Golden Rules? So Osborne has flexibility built in here with his "structural deficit" too.

But the important question: will Osborne backtrack on the cuts? Under his current model, he can’t. Departmental spending is set in stone, and if the cash budget is fixed then inflation will only
deepen their impact.

So in total: cuts of 3.7 per cent spread over four years. The government’s refusal to mention this figure has allowed Labour to make out that the cuts are deep and fast when in fact they average
less than 1 per cent a year. With the bond market as jittery as it is, I don’t think Osborne can afford to go any slower. But under the model he has chosen, that is not an option anyway.

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