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13
Budget 2008
2
M
 aintaining
 
MacroeconoMic
 
stability 
The world economy is acing a more challenging environment than was apparent at the timeo the 2007 Pre-Budget Report, with continued disruption in global nancial markets. TheUK is well placed to meet these challenges thanks to the resilience and stability engenderedby the Government’s macroeconomic ramework and a decade o reorm promoting openand fexible labour, product and capital markets.In 2007 the UK economy continued to perorm strongly, growing 3 per cent on a yearearlier, the astest growth rate among the G7 economies. Infation returned to close totarget in the second hal o 2007. Employment growth picked up during the year, withemployment reaching a record high o almost 29½ million; unemployment continued to all,and the claimant count reached a 32-year low.Despite the impact o nancial market disruption on the public nances, the Budget 2008projections show that the Government is meeting its strict scal rules:the current budget shows an average surplus as a percentage o GDP over the
•
economic cycle which began in 1997-98, ensuring the Government is meeting thegolden rule. The current budget moves clearly into surplus rom 2010-11 onwards;andpublic sector net debt is projected to remain low and stable over the orecast
•
period, stabilising below the 40 per cent ceiling set in the sustainable investmentrule.The reclassication o Northern Rock to the public sector will bring its assets and liabilitiestemporarily into the public nances. In line with the
Code or Fiscal Stability 
, while NorthernRock remains in the public sector the Government will measure perormance against thesustainable investment rule using gures excluding its impact. An updated analysis o long-term scal sustainability is published alongside this Budget inthe 2008
Long-term public fnance report
. This report conrms that the Government willbe in a position to meet its scal rules in the long term, ensuring that the long-term public nances remain sustainable.
The Government’s macroeconomic ramework is designed to maintain long-term
2.1
economic stability. The monetary policy ramework seeks to ensure low and stable ination.The fscal policy ramework seeks to maintain sound public fnances in the medium term, whileallowing fscal policy, and in particular the automatic stabilisers, to help smooth the path o theeconomy. Both parts o the ramework work together in an integrated way to support growthand stability, providing the exibility to respond to changes in the economic environment,and the context or ongoing policy reorms to address uture strategic challenges.
1
 
1
For the Government’s updated analysis o the strategic challenges acing the economy see
UK economy: analysis o long-term perormance and strategic challenges,
HM Treasury, March 2008
 
2
M
 aintaining
 
MacroeconoMic
 
stability 
eFsr
14
Budget 2008
REVIEW OF MAIN DEVELOPMENTS
In July 2007 problems related to the US sub-prime mortgage market triggered
2.2
disruption in global fnancial markets which has spread switly across countries and markets.In the 2007 Pre-Budget Report, the orecast or growth in 2008 was reduced by ½ percentagepoint compared with the Budget 2007 orecast, on the assumption that there would be someeed-through rom fnancial market disruption to tighter credit conditions and to householdand company spending in the short term. Adjustments were made to the fscal projectionsto reect the impact on receipts rom the fnancial sector. Given the uncertainties, thisadjustment was in line with the Government’s prudent approach to fscal management, and asthe detailed analysis o the fscal position below shows, proved to be a reasonable adjustmentor 2007-08.The fscal policy response at the time o the 2007 Pre-Budget Report was to
2.3
accommodate the impact o fnancial market disruption, with modest discretionary fscalloosening in 2007-08 and 2008-09, ollowed by fscal policy tightening in the medium term.This was in line with the Government’s objectives or fscal policy, o ensuring sustainablepublic fnances in the medium term and smoothing the path o the economy in the shortterm.Since then, the disruption in fnancial markets has continued. Concerted action by 
2.4
the world’s major central banks has helped somewhat to ease pressures in money markets, butconditions in credit markets deteriorated and a number o markets remain eectively closed.There has been urther evidence o developments in fnancial markets eeding through totighter credit conditions acing households and companies. The Budget 2008 orecast assumesthe negative impact on growth rom these developments will be somewhat larger and moreprolonged than expected in the 2007 Pre-Budget Report.Ination is currently close to target, but signifcant increases in global agricultural
2.5
commodity and energy prices are expected to lit ination in the short term. In addition,the recent depreciation o sterling will exert continued upward pressure on prices. As aresult, ination is expected to pick up in the near term, beore alling back by the end o 2008,returning to target in 2009 and remaining on target thereater.The Budget 2008 public fnance estimates show the defcit on the current budget in
2.6
2007-08 to be in line with the 2007 Pre-Budget Report projections. The estimated outturns orborrowing and debt in 2007-08 are lower than expected at the Pre-Budget Report, with debt just over 1 per cent o GDP lower than the Budget 2007 projection. This comes in the contexto low and stable borrowing delivered by the fscal ramework, and a reduction in debt overthe cycle rom 41.3 per cent in 1997-98 to 36.6 per cent in 2006-07.The public fnance projections rom 2008-09 onwards are aected by the continuation
2.7
o fnancial market disruption, by lower asset prices, with global stock markets lower, andby the impact o tighter credit conditions. The expected short-term increase in ination andsocial security payments also increase spending. As a result, there is an increase in borrowing concentrated in the years in which tighter credit conditions are assumed to have their largestnegative impact on the economy. This increase in borrowing supports economic stability,in line with one o the key purposes o the fscal ramework. The Government is also taking action in Budget 2008 to maintain sound public fnances in the medium term. On the basis o cautious orecast assumptions, outlined in more detail below, the Government is meeting itsstrict fscal rules throughout the projection period.
 
eFsr M
 aintaining
 
MacroeconoMic
 
stability 
2
15
Budget 2008
THE MACROECONOMIC FRAMEWORK 
The design o the macroeconomic ramework introduced in 1997 recognises that the
2.8
discretion necessary or eective economic policy – short-term exibility to meet crediblelong-term goals – is possible only within an institutional ramework that constrains thegovernment to deliver clearly defned long-term policy objectives with maximum opennessand transparency.The monetary policy ramework seeks to deliver low and stable ination by ensuring 
2.9
that interest rates are set in a orward-looking manner to meet the Government’s symmetricalination target. The
Code or fscal stability 
sets out a clear ramework and set o obligationsconstraining how Government conducts fscal policy, including the requirement or theGovernment to set out its fscal policy objectives and the rules through which policy willbe operated.
2
The fscal rules are also the oundation o the Government’s public spending ramework, which acilitates long-term planning and provides departments with the exibility and incentives they need to increase the quality o public services and deliver specifedoutcomes.Both the monetary and fscal policy rameworks allow or action in the ace o 
2.10
economic shocks while saeguarding the Government’s commitment to long-term stability.These rameworks have ensured low interest rates, low ination and allowed the UK to be theonly major economy to have achieved continuous positive growth over the past decade. Thisstrong perormance was achieved despite several signifcant economic shocks, including the Asian crisis o 1997, the Long-Term Capital Management hedge und collapse and Russiandebt crisis o 1998, the bursting o the dotcom bubble in 2000, and the impact o the terroristattacks o 11 September 2001 and the sustained increase in oil prices since 2002. A decade ater the introduction o the macroeconomic ramework, and ollowing 
2.11
continued reorms to promote exible and open product, labour and capital markets, thereis clear evidence that the UK economy is more resilient than in the past, as illustrated in Box 2.1 and discussed in Box B4 in Chapter B. The benefts have been seen in much enhancedmacroeconomic stability, as noted by the IMF: “Wide-ranging structural reorms over the pasttwo-and-a-hal decades have increased the economy’s openness and exibility, paving the way or reaping important benefts rom globalization. Macroeconomic policies have contributedto growth and stability, encouraging households and businesses to plan or the long term andpositioning the economy well to respond to shocks.”
3
2
Code or fscal stability 
, HM Treasury, 1998.
3
From the latest IMF sta report on the UK economy:
United Kingdom Article IV Sta Report
, International Monetary Fund,March 2007.
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