The next chancellor’s spending cuts will have an impact on growth. One of the worries in the Treasury is lower than expected growth will then up the ante on the cuts required to tackle the deficit. It is an horrible negative feedback loop.
If you want a sense of the scale of the challenge, take a look at Chris Giles fascinating piece on the impact of the deficit reduction plans using a replica of the Bank of England’s economic model.
The economists at Fathom Consulting estimate that in order to maintain 3.5 per cent growth next year, the economy would need to be growing at an underlying rate of 7 or 8 per cent.
Mr Gabay said the Bank’s model forecast that tax rises already announced would permanently reduce the level of national income 1.5 per cent, or £22bn. The £37bn of public spending cuts required in the next three years if the deficit is to be halved will reduce national income anorther 2.5 per cent by the middle of next year.
“I do not think that many, including the monetary policy committee, have really come clean on this,” Mr Gabay said.
“The MPC is forecasting 3.5 per cent growth next year. That would imply ‘underlying’ growth of between 7 per cent and 8 per cent.”
That does strike me as somewhat optimistic. George Osborne has in the past attacked Alistair Darling’s “heroic assumptions” on growth. There’ll be a new independent body to forecast growth under the Tories. But it may deliver some unwelcome news. If growth rates are adjusted downwards, the job of reducing the deficit will become that much harder. It will mean more cuts to an even more fragile economy.