George Osborne

The new Funding for Lending Scheme (FLS) announced today in the UK is a useful and sensible development. It directly attacks the important micro problem of inadequate lending to small and medium sized enterprises (SMEs). But it is unlikely to have large scale macro-economic effects.

The FLS was introduced last July to address the increase in the funding costs which British banks were incurring as a result of spill-overs from the eurozone crisis. This had increased lending rates on UK mortgages and corporate loans at a time when the monetary policy committee was trying very hard to ease overall monetary conditions in the UK. And the FLS was the chancellor’s main response last year to the charge that he was deaf to the needs of the real economy, and inflexible in his pursuit of austerity policies.

Almost a year later, the verdict on the FLS is that it has significantly reduced banks’ funding costs, with the benefits of that being mostly passed on to mortgage and company borrowers, but that it has had relatively little effect on overall bank lending to companies, especially to small and medium sized enterprises (SMEs).

Today’s extension to the FLS greatly increases the incentive for banks to skew their lending to SMEs by offering them larger overall access to subsidised funding if they do that. Every pound of SME lending in 2013 will contribute tenfold to the banks’ eligible total of subsidised FLS lending. In 2014, it will contribute fivefold.

Furthermore, today’s announcement extends the FLS by 12 months to the start of 2015, thus re-assuring banks that their access to cheap funding for new lending will not suddenly disappear early next year. The Chancellor also hopes that the new FLS will help to influence the IMF’s response to his overall economic approach when they visit the UK shortly. Read more

Predictably, the chancellor has rejected calls for a radical change in his economic strategy. Plan A has not morphed into Plan B. If anything, it has become Plan A-plus, with the underlying path for fiscal tightening left unchanged, and a little more flexibility for the Bank of England to pursue unconventional monetary stimulus.

UK real GDP is still stuck some 5 per cent below its pre-crisis level, the worst record among the major economies, apart from Italy. Some of this is certainly due to the problems which the Coalition inherited. However, about half of the shortfall in UK growth in recent years, compared to that in the US, is due to the tightening of 5 per cent of GDP in fiscal policy since 2009/10.

The dominant criticism of the government from mainstream economists is, of course, that the poor performance of UK GDP is due to a shortfall in aggregate demand, which in turn is primarily due to these fiscal measures. The Chancellor’s reply is that the UK could have faced a fiscal crisis without his budgets. The fact that public debt is now forecast to rise to 85 per cent of GDP in 2017/18 suggests that his concerns are not easy to dismiss as scare-mongering. Read more

In recent years, UK Budget Day has become the occasion for an outbreak of hand-wringing from the economics profession. Downward revisions to GDP forecasts, and upward revisions to budget deficit projections, have become the norm.  Those who have criticised the chancellor for tightening fiscal policy far too quickly have increasingly felt vindicated. Calls for a Plan B, involving less fiscal stringency in the immediate future, have become deafening.

Today may be rather different. For the first time in quite a while, there is no good reason for the Office for Budget Responsibility to downgrade its previous views on the economy. The underlying improvement in the budget deficit (adjusted for the absorption of the Royal Mail pension fund into the government accounts) will stay much the same as the OBR expected in November. If you believed it then, there is no new reason to doubt it now. That should allow the chancellor to focus on micro-economic issues, such as the tax treatment of higher earners, which will generate enormous political heat, but which will not alter the path for the economy very much in either direction.

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The political and economic debate on fiscal policy has become increasingly polarised in many countries, and as a result seems to have reached a dead end. Some economists are so concerned about the present rapid rise in government debt that they favour immediate fiscal tightening. Others are so concerned about the risk of renewed recession, and are so unconcerned about the risks from extra public debt, that they demand immediate fiscal easing on a large scale.

In many economies, this debate has now reached a stand-off, in which governments are trying to reduce deficits and debt only very gradually, while hoping that a recovery in private expenditure will keep the economy out of recession. The result, which satisfies nobody, is very slow GDP growth and a continuing rise in public debt ratios. Read more

So what did the Chancellor actually do today to change macro-economic strategy in the UK Budget? Read more

Britain’s Chancellor George Osborne has embarked on an audacious shift in the mix of fiscal and monetary policy. But despite unexpectedly high inflation figures on Tuesday, and ongoing worries about growth, the current combination of tight fiscal and easy monetary policy remains the best chance of avoiding a sovereign debt crisis while ensuring acceptable increases in gross domestic product.  Read more

The public spending plans published by the UK government yesterday promise the most austere path for departmental spending on public services since the 1975-1980 period. And allowing for the cuts planned in welfare benefits, the overall settlement for total public spending is the most draconian since 1945. Read more