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Reality check: will the coalition’s deficit reduction strategy work?

The government could be losing its battle to reduce the deficit meaning further spending cuts or tax increases may be necessary, according to reports today. We ask the experts to assess the coalition’s chances. Email or contact me on Twitter @pollycurtis

12.07pm: The Financial Times reports today that the government is facing a £12bn blackhole in the public finances, raising questions about whether the current deficit reduction strategy is on course to hit is 2015 target to eliminate the structural deficit. If off-target, the chancellor faces an agonising decision of how to cut spending or raise revenues further.

The FT reports:

Ministers are set to be told this autumn that a £12bn black hole has opened in the public finances, in a forecast that threatens to derail the coalition’s deficit reduction strategy and prolong austerity well into the next parliament. The Financial Times has replicated the model of government borrowing used by the independent Office for Budget Responsibility, which suggests the structural deficit in 2011-12 is now £12bn higher than thought, a rise of 25 per cent.

With only two months to go before the chancellor’s autumn statement on November 29, the coalition is on course to face the choice of prolonging austerity measures well into the next parliament or to introduce more spending cuts or tax increases to balance the government’s books on the current schedule.

Reducing the deficit is the single biggest test of the coalition. The Office for Budget Responsibility will make its official economic forecast in November, in time for Osborne to adjust his Autumn statement, due on the 29th, if the current strategy doesn’t seem to be working. To put it in context, to reduce the structural deficit by another £12bn would take something as drastic as increasing VAT from 20% to 22.5% to achieve.

The FT say they have repeated the OBR’s methodology to come up with the new forecast, which suggests Osborne will have to take action to meet his own target. But do other economists agree? What is the City expecting? We are going to canvas to assess the mood. This exercise is speculative, so we don’t expect to reach a verdict, but to gauge the experts’ opinions.

Do you know of any evidence that might be relevant? Email or contact me on Twitter @pollycurtis

12.23pm: Carl Emmerson, deputy director of the Institute for Fiscal Studies, points us to table 5.1 on page 157 of the OBR’s forecast from March. This fan-chart reveals the probability that the deficit reduction programme will eliminate the structural deficit by 2015/16. Back then, it was 70/30 in favour of the government.

The document is available here.

Emmerson says that most economic indicators published since March would suggest that the 70% probability that the government would achieve its aim within the time frame is ebbing away. He says:

Clearly there’s a lot of uncertainty in the forecasts. The idea that Mr Osborne’s plans were safe was never the case. The OBR forecast in March a 70% chance of success, 30% of failure. In March that left a bit of wiggle room but still a 30% chance of failure.

What we know now is that it’s getting closer to 50/50 chance. It’s never a black and white case of yes or no with this target. It’s getting more likely that we are going to have to see more pain in the next parliament – the squeeze in spending will go on or tax rises. The chances of a pre-election give-away look less likely. Austerity is getting more likely to continue into the next parliament. So we could be in the black a year later, in the next parliament rather than this one.

In a year that could change. but what looked like a bit of wiggle room in Mr Osborne’s forecast might have been used up. That’s only changed over the last six month period. Who knows what will happen in a year.

12.45pm: Jonathan Portes, director of the National Institute of Economic and Social Research and previously chief economist at the Cabinet Office, says that his organisation’s calculations, using a different methodology, suggest that the government is even less likely to hit its targets. Details of their last calculation, in August are here (pdf). The report says:

The public finances will not improve as quickly as the OBR expects. Weaker growth, and in particular weak consumer spending, in the short term, are behind this. Public sector borrowing will shrink by only 1 per cent of GDP in 2011–12. The Chancellor will miss his primary target of balancing the cyclically adjusted current budget by 2015–16 by around 1 per cent of GDP. The Chancellor has time to address this and further consolidation should not be introduced now. Indeed, it remains our view that in the short term fiscal policy is too tight, and a modest loosening would improve prospects for output and employment with little or no negative effect on fiscal credibility.

Portes says:

We said in our last forecast that we think that on current plans government is not on target to meet the deficit reduction strategy. Our forecast is that growth is somewhat weaker than expected. This was our forecast six weeks ago and to put it in the best possible light the outlook does not look better since then. If anything the position is somewhat worse.

Leaving aside the numbers the question of what the government will do if they go off-target is fascinating. The fact is that their fiscal rules say that if what the FT is right, or we are right, then in principle according to their own rule they should be tightening fiscal policy in the autumn statement. The question is are they going to do the sensible thing or stick to their rules and make even deeper cuts? © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds