Pre-Budget Report

I intend to discuss how to try to get banks lending to each other again in due course. Creating a ““bad bank”” to deal with toxic assets is not necessarily the right way forward, partly because it is incredibly difficult to value those assets appropriately and the Government end up taking all the very worst of the debt without appreciating its true value. Of course, everything ought to remain an option as we go through these difficult times. The Opposition have failed to appreciate a fact that was the essential point of my right hon. Friend the Chancellor's statement. In a global credit crunch the impact of monetary policy is at best uncertain and at worst negligible. Evidence mounts day by day, week by week, and even though the 1.5 per cent. interest rate cut was passed on to people with tracker mortgages, credit conditions remain incredibly tight. That is the case for mortgage holders but more particularly for small and medium-sized enterprises. There is evidence that good going concerns are being refused credit, that the availability of credit is shrinking and that the price of terms that have already been agreed has also increased. Although the 1.5 per cent. cut has been passed on to those with tracker mortgages, the spread between inter-bank lending rates and base rates remains stubbornly high and there is no immediate sign that it will be reduced. In such circumstances, it would be hugely unwise to rely on monetary policy as the way out of the recession. Of course, monetary policy might help somewhat and if there are further deep cuts in interest rates they might act as a stimulus, but we should not bank on those measures as the only stimulus. In precisely such credit constraint conditions, fiscal policy becomes ever more potent. I am glad that the Opposition have at least come to realise the importance of using the automatic stabilisers—a term that is now entering common currency—as tax receipts fall during a recession and benefit payments rise. It is incredibly important that the automatic stabilisers are used not to provide a fiscal stimulus—they do not do so—but to prevent fiscal policy from tightening and exacerbating any potential recession. All credible economic commentators around the world seem to concur that a fiscal stimulus is needed, rather than just a use of the automatic stabilisers. In fact, the Bank of England, which published its quarterly inflation report yesterday, assumed as its central prediction that output would start to pick up from the middle of next year. The Bank of England, far from making the Government's case look somehow out-of-step and over-optimistic, also expects growth to resume from the middle of next year. However, it did not take into account the potential impact of any fiscal stimulus. The report states that"““the slowdown may be less pronounced if…there is a stronger stimulus from fiscal policy.””" It is not just the Bank of England. The Institute for Fiscal Studies welcomed the fiscal stimulus this morning, as did the CBI. Abroad, we are backed in our resolution by the IMF and by most credible economists and commentators. The argument against the use of fiscal policy usually rests on the following facts. First, people think that it takes too long to implement and if not carefully designed can end up turning a fledgling recovery into an unsustainable boom. Secondly, some people argue that if taxes are cut in the short term people will not necessarily spend the extra money because they think that taxes will rise in the medium term. Thirdly, people think that a fiscal boost could add to inflationary pressure. The likelihood of inflationary pressure being a problem seems entirely remote and should not keep many people awake at night. Let me turn to the first two potential problems. Will the cut in VAT and bringing forward spending take too long to implement? Absolutely not. As we know, the cut in VAT has been turned on take effect almost immediately and is clearly temporary, so VAT will rise in the future. The beauty of the VAT reduction is that unlike direct income tax cuts it can be implemented virtually straight away and can clearly be seen to be temporary. Given the potential severity of the downturn, it does not seem at all plausible that the measure could end up stoking a domestically generated boom. I find it extraordinary, incidentally, that the Liberal Democrats are arguing that a permanent funded tax cut could ever act as a temporary fiscal stimulus, but I leave that to their spokesman to explain in the future. Is it the case, as the Opposition sometimes seem to argue, that people would just pocket the reduction in taxes and not spend the money to produce the desired stimulus? I find that hard to believe given that households across the income spectrum are credit constrained. That is what is happening with the global credit crunch. When people have more money in their pockets to spend, they tend to spend it. The Government have made a fairly conservative estimate, saying that about half will be spent and half will be saved. However, even if half that money is saved it will be because people are paying back their debts, and that will place them in a stronger position to spend in the future. The Government forecast that the reduction in the impact of the recession will be about half a percentage point. It is easy to underestimate that effect. That reduction will keep a much larger number of people in their jobs throughout this downturn than would otherwise have been the case. It will keep more small businesses afloat, many of which would have gone bust during the economic downturn. Of course, all that is likely to be far more powerful if countries act together rather than independently. When people spend their money on fiscal boosts, some of it will clearly go on imports from other countries. If everybody acts together, the impact of a fiscal stimulus is likely to be far more powerful. For that reason, we should welcome the fact that Japan, Germany, Spain, South Korea and China have announced or are planning a significant stimulus package. In particular, we should welcome the move announced yesterday by the United States. The injection of $800 billion into the US economy should have a pronounced effect not just on them but on us. What happens to the public finances over the medium term is obviously important when it comes to the UK's position. I noted that the hon. Member for Tatton (Mr. Osborne) talked about the seven-year figures as fantasy figures. I cannot agree with that. What is the alternative? When a global credit crunch causes permanent deterioration in and damage to the output of the economy and when one cannot foresee how quickly corporate profitability will increase in the future—it will clearly remain low in the medium term—it is right that we should take our time before public finances are brought back to balance. The alternative, which would be to bring them back to balance much more quickly, would risk tightening fiscal policy at a time when another shock might come along in the system and make it worse.