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29 October 2008

The Mais Lecture on 'Maintaining stability in a global economy' given by The Chancellor of the Exchequer at the Cass Business School, London EC1

Check against delivery


It is a pleasure to be invited to the Cass Business School to deliver this year’s Mais Lecture.

We meet at a time of unprecedented turbulence in the world economy.

And tonight I want to set out how governments should respond to this new challenge, which I believe demands a new response – both at home and abroad. Because this is now a truly global challenge.

But while the challenge we face today is different, our objective remains the same – to maintain a strong and stable economy – which is the only way to provide jobs, security, greater opportunity and increasing prosperity for the people of this country.

Three weeks ago, we worked with other countries to put in place a plan to stabilise the banking system. And governments everywhere are committed to working together to strengthen supervision in the global financial system.

And today we need the same determination to support the wider economy. To ensure that fiscal policy supports monetary policy, here and across the world, in these exceptional circumstances.

And I will argue that the fiscal rules we adopted over ten years ago – which target debt and promote investment – enabled us to triple public investment, at the same time as cutting debt to one of the lowest levels among the world’s major economies.

But to apply these rules rigidly in today’s changed conditions would be perverse.

We must respond to the challenges and uncertainty we face today – supporting the economy now and maintaining public investment – while at the same time ensuring that we live within our means in the medium term.

Economic policy prior to 1997

Policy needs to address today’s problems – and to do that, I believe it is useful to look at the performance of the UK economy over last 50 years.

A clear picture emerges. The 1950s and 60s saw a rapidly expanding world economy. The UK, however, grew less rapidly than others. The 1970s and 80s brought high inflation and massive unemployment. And in the early 1990s we again saw job losses in most advanced economies, but in our case, coupled again with high inflation.

In other words, when the UK did well, others did better; and when others did badly, the UK did worse.

Our poor economic performance was largely the result of inadequate policy decisions by successive governments. And these decisions, in turn, arose from inadequate policy frameworks.

Thanks to the reform of economic policy in 1997, we have seen the longest period of continuous growth in living memory. But today we have to deal with unprecedented turmoil in the global economy.

To all of you here tonight, the story of the last thirty years can not only be told with statistics and policies – it can also be told through the Mais lectures.

Following the devaluation of sterling in 1967, inflation started to increase, reaching nearly 10 per cent by 1971. The oil shocks that followed meant that inflation remained high during the 1970s. Annual inflation here averaged the highest across the G7 countries, peaking at almost 27 per cent in August 1975.

Much of this poor record can be put down to a failure of macroeconomic policy, which was focused on the wrong objective - keeping unemployment low with no regard to inflation.

This is the background against which Gordon Richardson, then Bank Governor, delivered the first Mais Lecture 30 years ago. His contribution, and that of Lionel Robbins the following year, were part of an emerging consensus. Not surprisingly, after the high inflation of the 1970s, the correct objective of monetary policy should be to stop inflation.

Indeed, one of my predecessors, Geoffrey Howe, titled his 1981 Mais Lecture “The Fight Against Inflation”. But while the objective might have been clear, its implementation caused huge problems for the economy.

Inflation was brought down to around 5 per cent, partly due to the emphasis on controlling money supply and the Government’s dramatic spending cuts in the 1981 budget. But this came at the expense of very high unemployment and the erosion of Britain’s industrial base.

Nigel Lawson used his 1984 Mais Lecture to move the debate forward. Stabilising the economy and controlling inflation, he said, had to be achieved with macroeconomic policy, and not micro-level interventions or deflationary fiscal policy.

Assigning the stabilisation role to monetary policy was a necessary step forward. But, in retrospect, it was not a sufficient one.

In the decade up to 1987 the UK tried to achieve low inflation by targeting the quantity of money in the economy. This was in line with the monetarist wisdom of the times.

Monitoring the quantity of money is difficult during a period of financial liberalisation – and the record now looks poor.

Furthermore, the failure to separate fiscal and monetary policy responsibilities meant that Chancellors would reward themselves, by following a budget with an interest rate cut. And this made people question the government’s commitment to low inflation.

Between 1987 and 1992, the Government sought to bring price stability by targeting the exchange rate. The results, again, were mixed. The period saw considerable price volatility, with inflation ranging between 3 and 11 per cent. And in 1992 the pound was forced out of the Exchange Rate Mechanism.

It was only after October 1992 that the then Government adopted an explicit inflation-targeting regime. While this was a step forward, the objective and process of monetary policy was still not clear. The arrangements weren’t sufficiently transparent or forward-looking and, because interest rate decisions were still being made by ministers, they lacked credibility.

But the problem of macroeconomic instability in the decades before 1997 cannot be attributed to monetary policy errors alone. Successive governments failed to fully consider the economy’s cyclical position in their fiscal projections.

In the mid 1980s, for example, it was thought that the economy could grow at a higher sustainable rate. Fiscal policy was loosened in the 1988 budget. Many, Nigel Lawson included, now admit that the economy was growing too fast – and policy exacerbated this unsustainable expansion leading to rising inflation. This, coupled with the straightjacket of ERM membership, resulted in the recession of the early 1990s.

In summary, what can we learn from past experience?

Three key themes recur. First, the need to beware of excessive rigidity. The Monetarism doctrine, for example, adhered to excessively rigid intermediate goals just when policymaking needed the flexibility to support the economy.

Second, the need to specify clear objectives. Their absence made policy appear overly political, short-termist, and lacking transparency

Third, there was often no medium-term strategy, particularly in the case of fiscal policy in the 1970s and 1980s.

This was how home-grown policy-errors, as opposed to global events, resulted in two recessions in the space of a decade.

And in 1997 we were determined not to repeat the errors of the past.

The Government’s economic purpose

We wanted policy to adapt – to the new times and to the new aspirations of the people who had elected us.

Let’s pause for a second – to remind ourselves why we do this. It seems to me that we sometimes fail to explain how governments can make a difference to people’s lives and prospects.

It is vital that we explain what a stable and strong economy means to people.

It means, first of all, jobs. A growing economy generates employment, which allows people to take control of their future. And a stable economy means job security for people and businesses.

But the number at the bottom of your pay slip is only one side of it. What also matters is how much you can buy with your money.

And that’s why controlling inflation matters. By achieving low and stable inflation people can be sure about the purchasing power of their future income. They know that they can provide for their families and keep running their businesses.

High inflation is not only damaging in itself – once it becomes built into people’s expectations, lowering it can have a huge cost in terms of jobs, as we saw in the 1970s and 80s. Furthermore, high inflation is socially divisive. It hurts some groups more than others. Those on fixed and low incomes invariably bear the brunt.

Maintaining low inflation is a job for central banks and for governments. It’s about price stability but also about fiscal sustainability. When I talk about maintaining sound public finances – this is also about making it possible for monetary policy to stabilise the economy. By creating certainty about the sustainability of the fiscal position, monetary policy can keep inflation low.

Fiscal policy has to support monetary policy. But it also has a purpose in itself.

Taxation enables a public sector that provides the things markets can’t. Universal healthcare, education or national defence. Or maintaining investment – in infrastructure, transport and housing. We tax so that we can run a modern welfare state that helps people into jobs. Left to the private sector alone it would never happen. The role of government is crucial.

And, of course, the success of modern economies also depends on a strong and efficient banking system. A system that allows people to save and invest for the future – but also supports the economy as a whole.

The role of Government

The Government has a crucial role, in building a fair and therefore more prosperous country – where everyone has the opportunity to make the most of their talents.

Not everyone encounters the same opportunities in life. But I believe that it is unfair that some people are held back through no fault of their own. That’s why I strive for a fair society.

My political purpose has always been to enable everyone, regardless of their background, to make the most of their strengths and to benefit from increasing prosperity.

Of course, there are limitations to what governments can do. Governments can’t make us all equal. They can’t replace the entrepreneurial spirit of individuals. And no-one can predict the future - or fully insulate everyone from economic shocks.

But governments can make a real difference with the right economic policies. We can make a difference to people’s lives. If I didn’t believe so, I wouldn’t be in politics.

That’s why, before 1997, we had decided on our priorities. Our economic objectives, both then and now, are:

Tonight I will focus on how stability, the most important objective of all, is facing unprecedented global challenges. And how policy should respond to these – across the financial, monetary and fiscal policy frameworks.

Stability is the platform that helps us deliver everything else. In his 1995 Mais Lecture, Tony Blair made the point that macro and micro policymaking are not only indivisible - they reinforce each other. Stability is essential to allow businesses to invest, to allow people to find work and plan for the future.

Economic policy and performance since 1997

That’s why in 1997 we introduced a policy framework that would deliver stability. It did so, by allowing us to avoid the errors of the past and make the most of the UK’s position as an open economy. To respond to the challenges and opportunities of globalisation.

And the principles of the new government’s macroeconomic framework were outlined by Gordon Brown in his 1999 Mais Lecture. They were credibility, flexibility and transparency. It’s worth looking at each in turn – because they’re important.

First, credibility. People need to believe that governments have a long-term strategy to ensure sound public finances. Without one, the cost of government borrowing would increase, and the economy as a whole would suffer. The same is true of monetary policy - markets need to believe that low inflation will be achieved.

Second, flexibility. We must be able to act in response to shocks that cause fluctuations in the economic cycle. And we need a framework that allows us to react speedily and without undermining long-term credibility.

Third, transparency, which allows flexibility and reinforces credibility. By publishing forecasts and explaining decisions, policymakers can illustrate the uncertainty surrounding their judgements. This transparency builds legitimacy and, through Parliament, allows public scrutiny.

The framework we introduced in 1997 aimed to achieve these three objectives. Taking the operation of monetary policy away from government boosted credibility. We made the Bank of England operationally independent, giving it full control over interest rates. And this was the first time macroeconomic stabilisation had been clearly separated from the government’s wider economic policy objectives.

We also achieved credibility by signing up to specific quantifiable goals. In the case of monetary policy this came in the form a clear inflation target and a process for meeting it. With fiscal policy, the Government’s two fiscal rules – to target debt and to maintain investment – provided a medium-term constraint on the public finances.

Transparency was increased too. A greater flow of information makes it easier to understand how flexibility is being applied. The Code for Fiscal Stability, publication of MPC minutes, the Long-Term Public Finances Report – are all examples of increased transparency. Many of them backed by legislation.

Recent events demonstrate the importance of a robust system of financial supervision.

That’s why, in 1997, we also consolidated the system of regulation, bringing together seven different agencies, including what had previously been industry self-regulatory bodies, under the umbrella of the newly created FSA.

Looking back, the operation of the macroeconomic framework between 1997 and 2007 was successful.

Inflation averaged 3 per cent, compared to over 8 per cent in the previous three decades.

Long-term interest rates averaged around 5 per cent, compared with almost 10 per cent.

The average current budget between 1997 and 2006 was in balance, the only time this has been achieved over a cycle since the early 1970s.

This is how the Government managed something many thought would be impossible – to triple public investment while at the same time cutting government debt.

In other words, we did fix the many roofs that needed fixing – the roofs of schools, hospitals and homes throughout the country. And no-one at that time was arguing for less spending on education, health or transport.

We also had enough flexibility to accommodate shocks – negative ones, such as the bursting of the technology bubble in 2000 – as well as positive shocks, such as the receipts from the spectrum auctions, which we used in full to pay down debt.

Thanks to this stability, the economy grew. Importantly, unemployment, which had peaked at close to three million twice in ten years, came down as a result – creating three million new jobs.

It wasn’t easy. This is the result of tough policy choices. Like the choice of spending the £23bn we made from the spectrum auctions, not more spending, but to pay down the government debt we inherited.

But, as Mervyn King said here three years ago, policy will continue to adapt. The rules we had in 1997 were there to deal with domestic problems – correcting the underinvestment in public services and keeping inflation under control.

Global shocks

Looking back over 30 years of Mais lectures, I see many attempts to find solutions to domestic problems. But one aspect of modern policymaking which seems to have been understated is the impact of global events.

Perhaps not surprisingly – globalisation has been with us for hundreds of years. But the speed and breadth of global change has increased dramatically in recent years – as we can see today.

This is why, it’s worth recalling the Mais lecture delivered by Roy Jenkins in 1986. Interestingly, his lecture is almost impossible to get hold of.

He saw the risks building up due to the integration of the global financial system. He said that “the international banking system … has substantially increased its vulnerability. Any major shock now inevitably unleashes huge destabilising capital flows”. That was 22 years ago.

When talking about new bank lending practices, he warned of the risks of securitised lending, as well as the tendency of banks to concentrate less on managing loans and more on acting as a junction between borrowers and investors.

I am not opposed to globalisation, far from it. And neither was Roy Jenkins. The opportunities offered by international integration – opening new markets, sharing new ideas – are endless. And we must be ready to seize them as we come through this time.

Indeed, we have helped the UK make the most of the globalised economy. This is why, while other countries have increasingly moved towards protectionism, the UK has remained committed to openness and free trade, pushing it right up the international agenda.

And openness will remain the approach of this Government – making the most of the opportunities available to the UK in the global economy.

But there are new challenges to be met. The confluence of two global shocks is now hitting every country in the world. The combination of the global credit crisis and the surge in commodity prices is unprecedented.

Many forces came together over the past 15 years to set the stage. First, we saw increasingly integrated global financial markets, with enormous amounts of capital flowing across borders every day. Second, improved policy frameworks delivered low inflation and low interest rates across the developed world. Third, the massive build-up of emerging markets’ foreign exchange reserves, invested mainly in US assets, pulling down long-term interest rates to historic lows.

Because returns on conventional investments were low and borrowing was cheap, financial institutions searched for higher yields. Complex products were devised to repackage securities into new investment opportunities.

Advances in information technology made possible the repackaging, and global distribution, of these securities. And banks borrowed heavily from global capital markets to fund their investments.

Now that investors were over-paying for risky assets, demanding inadequate returns for the risks involved. In other words, a global credit bubble had formed - with a belief that repackaged assets could be worth more than the sum of their parts.

Yes, there were many benefits to the innovations in the world of finance. Many people were able for the first time to get a mortgage. Loans were easily available, making it easier to invest in businesses, projects, or courses of study. Capital became more internationally mobile.

But the banking industry, growing in scope and ingenuity, was storing up risks for the future – creating a need for international regulation.

That is how, last summer, we had a catalyst – the trouble in the American subprime mortgage market. Having paid too much for securitized assets linked to US subprime mortgages, financial institutions everywhere are revaluing them.

This week, the Bank of England’s Financial Stability Report, estimated subprime and related losses at almost three trillion dollars.

Because the global financial system was so highly leveraged, this shock is having a profound effect.

Because the system so is highly interconnected, the effect is quickly transmitting across countries.

And because the financial system is so complex, it is very hard to predict exactly where the effect will be felt.

This does raise some profound issues about the regulation of financial markets – and the need to monitor individual institutions as well as the system as a whole – and I will return to that later.

And the credit crisis is not the only shock to have hit the global economy. We have also seen a surge in commodity prices. Ten years ago oil prices were $10 a barrel, this summer they reached nearly $150.

The commodity price surge also reflects global forces. We’ve seen a decade of rising demand in emerging markets, pushing against a limited supply response.

More recently, commodity prices have fallen back, and that is undoubtedly a good thing for the economy.

But the consequences of these two shocks are being felt now – that is why the UK, as well as other countries, is moving into recession.

And crucially to my account tonight, the global shocks mean that the challenges faced by macroeconomic policy today are different to the ones ten years ago. These are new times – and they require a new approach.

The operation of policy will adapt to global shocks

So tonight’s lecture offers me the opportunity – to set out my view of what needs to stay the same and what needs to change across the range of macroeconomic policy.

The principles of the macroeconomic framework: flexibility, credibility and transparency – are right and must stay the same.

Hayek liked rules. Keynes liked discretion. I believe in a combination of the two.  The Prime Minister describes it as “constrained discretion”.

It means combining credibility with flexibility – to support the economy when it needs it most, and maintain investment essential if we are to face the challenges of the future.

But it also means having a transparent and credible medium-term plan to strengthen the economy.

And because today’s problems are global – affecting the operation of fiscal and monetary policy, as well as the financial system – so the solutions will also be global – requiring global cooperation.

Dealing with these shocks will need a comprehensive response. Let me turn first to financial stability and regulation. Then I will turn to monetary policy and the fiscal framework.

The framework for financial regulation and financial stability

The challenges to financial stability over the past year have been truly remarkable.

Many of the recent events in the banking system would have been unimaginable less than a year ago. Few predicted that each of the five large Wall Street investment banks would have, by now, either merged, sought government help or collapsed.

Today, governments all over the world are using approaches that until recently wouldn’t have been considered, like nationalising banks.

But it is right that the conduct of policy should evolve.  Just as markets change, so should policy. As Keynes said, “when the facts change, I change my mind”.

We are being flexible about keeping funds flowing through the system. Over the past year, the Bank of England has injected around £100bn against a wider range of collateral.

The Bank introduced the Special Liquidity Scheme, making available up to £200bn of funding to be lent through the scheme – with the facility now extended until January. 

We led the way internationally by introducing a guarantee on newly issued debt – to allow banks to start lending to each other again with confidence.

Central to the recovery is lending by banks to business, particularly small businesses. We’ve working with the banks to endure continued access to credit at competitive prices. And we have agreed, with the European Investment Bank, to the provision of commercially attractive loans to banks for onward lending to SMEs.

And while being flexible about our approach, we have also been strengthening the system for the future. This month the Government introduced new legislation, to formalise and improve the powers I took in February, to better deal with bank failures and protect depositors.

Crucially, stronger banks need more capital. The Bank Recapitalisation Fund has, so far, committed to making capital investments to banks totalling £37bn. Other banks have committed to raise an additional £11bn. This makes banks more resilient to future shocks and more willing to lend.

We also need to strengthen the regulatory system to adapt in response to recent events. It is not a question of light-touch or heavy-handed regulation. It is about more effective regulation.

Domestically, regulation should consider the issue of liquidity as well as capital. And look at the link between remuneration structures and risk-taking.

As I look at what has happened over the past few years, I believe that regulators do have to look far more – at practices that could destabilise the banking system. There is a clear public interest case here.

Adair Turner, the new Chairman of the FSA, is reviewing the system - and I will set out further details of our thinking in this area at the time of the Pre-Budget Report.

International financial stability cooperation

And as recent events showed, we also need more effective global regulatory cooperation. The UK was among the first to call for increased transparency of financial institutions' exposures, for improvements in the effectiveness of credit rating agencies, and agreements for enhanced capital adequacy requirements.

There have been improvements in risk disclosures by banks - and the steps being taken to establish 30 colleges of cross-border supervisors by the end of this year - but more needs to happen and quicker.

But in this new age of global markets, we also need new global institutions.  The problems we face are changing, and it is right that the means of solving them should change too.

We need international financial institutions that are fit for our times. Institutions that can prevent another global financial crisis and which foster global cooperation as a first, rather than last, resort.

The Prime Minister has been at the forefront of calls to create a new framework for global financial stability. These led, under the UK’s G7 Presidency in 1998, to creation of the Financial Stability Forum.

But the problem with the FSF today is that it has knowledge, but no power. And while the IMF has power, it has less knowledge. This is why we need the two of them to work better together, and with national regulators, towards a system that gives early warning of incoming global economic and financial shocks.

And for too long the world’s major nations have acted as an elite. We must think about how to better protect and include emerging market economies. Many of them are facing difficulties right now.

And it is clear to me that, just as Keynes proposed in 1944, we need a global system that provides temporary funding - where and when it is needed most - not only after, but also before, economies encounter a crisis. 

The world needs these new lending facilities - both at the IMF and now in the European Union. This is an opportunity to show how Europe can work together to support the wider economy.

Next month, world leaders and finance ministers will meet in Washington to discuss these global economic problems. 

And next year the UK will hold the presidency of the Group of 20. We will call on world leaders to increase the role - and funding - of the international financial institutions.

At all these meetings there will be a debate, about the role of government in the financial system. Some have asked whether we should step in to limit people’s desire to take on risk and smooth out the cyclical behaviour of financial markets.

Government can’t completely remove risk-taking from the system. But we do want to see far more responsibility.

The financial system today, for the most part, is capable of performing its core function - successfully spreading risks and funding worthwhile projects - better than in the past.

Successive governments have contributed to this. Some have claimed that we took powers to control personal debt away from the Bank of England. In fact, it was the government in 1979 that removed credit and exchange controls. Then in 1986 we had the “Big Bang” and wholesale liberalisation of financial services. And in recent years we have seen profound cross-border financial integration.

But we do need to act collectively to protect people when excessive risk-taking affects the system as a whole.

And that is why l have done whatever was necessary to stabilise and strengthen the financial system:

Financial stability and strong banks are an essential precondition to re-stimulating lending and an eventual recovery in the wider economy. 

And just as we led the way on global recapitalisation, we must lead the way when it comes to the wider global economy.

The framework for monetary policy

So let me turn to monetary policy. The Governor of the Bank of England talked about the NICE decade: ten years of non-inflationary constant expansion.

Compare that to the current challenges. No-one predicted the spike in commodity prices that we have seen in the last year – or their volatility.

This makes the job of MPC much harder. The two open letters that I have received from the Governor this year make this very clear.

That is not the only global challenge facing central banks. Many think the global credit crunch means interest rate decisions now take longer to affect economic activity. And uncertainty in financial markets is translating into currency volatility.

Some have called for the Government to change the way the Monetary Policy Committee sets interest rates.

But the global challenges we face today are no reason for changing the remit of the Bank of England. The objective, price stability, is the right one. The means of achieving it, by inflation targeting, is right too. What matters is that inflation expectations remain anchored.

That’s why tonight I want to reiterate my full support for the existing remit of the Bank of England.

Our monetary policy framework is, as the Governor pointed out in his Mais Lecture three years ago, based on constrained discretion. Inflation will come back to its 2 per cent target – a credible commitment. But there is also “discretion about the horizon over which inflation is brought back to target”.

In exercising this discretion, the MPC can support, in line with its statutory requirement, the Government’s wider economic objectives.

Surely, some have said, monetary policy needs to take into account the price of assets, such as house and share prices. This, they say, is the only way to prevent further volatility.

The newly independent ONS has been, for some time, working to agree an EU-wide measure of housing costs. This is difficult - there is no international consensus on how to include such measures in inflation – but it must be a priority.

Beyond that, developments in asset prices can affect consumer price inflation, of course. And it’s entirely appropriate for monetary policy to take that into account. But we should do nothing in terms of policy objectives that would undermine the achievement of price stability.

As Mervyn King said to the Treasury Select Committee in the summer, if interest rates had been raised by enough to burst a bubble in the past, “the number of people who would have been thrown out of jobs would have been far larger than the prospect with which we are now faced –because if would have required a massive rise in interest rates to break the bubble”.

In short, while the remit we have set the Bank of England is right, the conduct of monetary policy today will have to contend with difficult global forces. And I believe we need to ask difficult questions about the effect of international price shocks, the global credit crunch, and currency volatility.

The framework for fiscal policy

Finally, let me turn to fiscal policy. There are three points I would like to make. First, how global forces are affecting tax receipts across the world. Second, the role for fiscal policy when the economy slows. And third the implications for the fiscal framework.

First, we all know that tax is hard to collect at the best of times. But today we see global events further depressing tax revenues.

The credit crunch affects the tax take from the financial sector, which over recent years has been generating about 25 per cent of our corporation tax revenue.

Earnings in that sector are falling, bringing in less tax. As house and share prices fall, capital gains tax receipts fall while stamp duty is down. Increases in oil prices, contrary to popular belief, don’t provide a significant windfall for the exchequer.

Globalisation also presents challenges to the tax base in most advanced economies. Individuals, for instance, are increasingly mobile, and their financial arrangements more diffuse and complicated.

Activity between multinationals is now greater and more complex – indeed, cross-border direct investment flows have increased fivefold since 1980. And intangibles, which are hard to tax, are occupying an increasing role in developed countries economies.

It is clear we are facing a constellation of short and long-term challenges, placing extraordinary pressure on the tax revenues.

In response to these challenges, in April I set up the business-government forum on tax and globalisation. Although the forum's focus is medium term, it has already made a valuable contribution to our thinking on a number of international tax issues.

Second, I want to look at the role of fiscal policy when the economy slows. When that happens, spending rises as the Government supports people on low incomes, through the tax and benefits system.

And, at this time, I am helping those who need help most, by cutting income tax for the lower paid and freezing fuel duties this year.

When private activity slows, it is even more important to maintain wider public spending. This is why it is right to bring forward planned spending commitments – as with our housing package in September, which supported construction activity.

We must also make sure we maintain public investment – in infrastructure, education and health – because they are essential to our future economic strength.

And on energy – investment is essential to greater security of supply and as well as lowering carbon emissions.

To increase borrowing in a downturn is sensible – to support people and business across the economy.

It is right to put money back into the economy when the private sector can’t. And we can do this because we have cut public debt over the past ten years.

That brings me to my third point, the fiscal framework.

To apply the fiscal rules in a rigid manner today would be perverse.  We would have to take money out of the economy, exacerbating an already difficult situation.

I know of very few who would argue for this – just as there are fewer still today who talk about an annual balanced budget.

The fiscal rules we introduced in 1997, to target debt and promote investment, meant that, in the last ten years, we have tripled public investment and at the same time cut debt to one of the lowest levels among the world’s major economies. We met the fiscal rules over the past cycle.

Because we acted to cut debt and live within our means, we were allowed the flexibility to support the economy. This is how extra borrowing cushioned past slowdowns – in 2000 when the internet bubble burst and in 2005 when the housing market slowed.

And with the latest data supporting the view that the cycle ended in the second half of 2006, I have asked the National Audit Office to audit our assessment of the cycle in time for the Pre-Budget Report.

These are extraordinary times. The economy is facing unprecedented global shocks, and we need a new approach that is fit for these new times.

Here, in Europe, in the US – the way we meet our fiscal targets may well change – but the principles underpinning fiscal policy will not.

Rules provide a discipline on Government – they are a means to an end. And our core objective right now is to get the economy through these difficult times.
But we can boost the economy only because we have built a foundation of sustainable public finances – because governments everywhere must live within their means – and I will ensure that we do this in the medium-term.

What matters is that the public finances start from a position of strength, with public debt:

And people should be in no doubt that Government will take the decisions necessary, to ensure sustainability in the medium term. To return borrowing and debt to a sustainable level - once these shocks have worked through - just as we have in the past.

So I will set out plans at the Pre-Budget Report, that demonstrate our commitment to keeping the public finances on a sustainable path.

And through this very uncertain period, I am determined to explain more about what fiscal policy is for and how it is working, so that Government can be held accountable.

In summary, our fiscal framework leaves room for the rules to adapt to today’s global challenges. By:


The post-war years saw recurring instability in the UK economy. And often these were home-grown problems, rather than global ones.

Policy decisions often exacerbated the instability

Our objective ten years ago was to reform macroeconomic policy – to engender greater stability – and make the most of it of the opportunities available to this country.

The rules worked. We tripled investment, cut debt, lowered inflation and saw the longest expansion in recent history.

Today we face a profoundly different global economic environment. And these new conditions require a new approach. One that retains the principles that guided us over the past decade – but one that allows the right response to meet our objectives.

Just as we did with the banking system three weeks ago – adopting new ideas and letting go of the old ones – we now need to deliver stability in the wider economy.

And just as we secured international cooperation then – we need to do so again today.

Because this is the only way to bring prosperity and opportunity to the people of this country – and across the world.

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