Key questions about the Budget - 5


How bad will the recession get?

It is going to get pretty ugly. The closest the Treasury came to a precise estimate of its expected peak-to-trough loss of output was its forecast that gross domestic product would fall from £641bn in the first half of 2008 to £630bn in the first half of 2009. This implies a 1.7 per cent loss of output. The forecast compares favourably with the recessions of the early 1990s and the early 1980s when the economy contracted by 2.5 per cent and 4.6 per cent respectively.

The Treasury risks being seen as a Pollyanna with its forecasts. Most independent forecasters are moving to a position where they believe the recession will be at least as bad as the one in the early 1990s. The National Institute of Economic and Social Research expects a 2 per cent drop while the CBI and Capital Economics consultants believe the peak-to-trough fall in national income will be 2.5 per cent. They all believe household spending will be more sluggish for longer, investment will drop by more and unemployment will rise faster. The CBI expects unemployment to reach 2.9m by mid 2010.

Even if the Treasury’s forecasts are accurate, the sharp loss of expected output raises public expenditure as a share of GDP in 2009-10 from the Budget forecast of 41.7 per cent to 44.2 per cent. In contrast, tax revenues will fall much further than the economy. The Treasury expects government revenues as a share of GDP to tumble from 39.2 per cent in 2006-07 to 36.2 per cent in 2009-10, including the fiscal stimulus, implying public sector net borrowing of 8 per cent of GDP, or £118bn.

Public sector net debt balloons on the new Treasury forecasts, hitting 57 per cent of GDP in 2013-14 before it stabilises and slowly declines – a level thought unimaginable in Whitehall as recently as the spring. This blows out of the water Gordon Brown’s fiscal rule to keep debt below 40 per cent of GDP in “each and every year”.

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Methods there are many, principles but few, methods often change, principles never do