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The IFS economic forecast: one silver lining, five heavy black clouds

The Institute for Fiscal Studies thinks government borrowing will be lower than forecast. But it is far less sanguine about lost output, recession, public finances, austerity and the euro

A broken-backed economy with devastated public finances and a long, hard slog ahead. That’s a brief summary of what the Institute for Fiscal Studies was saying in its “green budget”, which sketches out the options for the chancellor in this year’s budget and beyond.

Before looking at the bad news – of which there is plenty – it’s worth mentioning the one or two snippets of good news. George Osborne has exercised such control over his cabinet spending colleagues that they are on course to spend £3bn less this year than the chancellor had allowed for. By 2016-17, borrowing will be £9bn lower than the projections made by the independent Office for Budget Responsibility last November. At the election, due to be held in 2015, Osborne may have a bit more wiggle-room for some vote-winning sweeteners.

The rest of the IFS report, though, is not for the faint-hearted. Concern number one relates to the enormous cost of the recession of 2008-09, which has cost £200bn in output lost for ever. Concern number two is that a second period of retrenchment is now under way, with the co-authors of the IFS report, Oxford Economics, predicting a double-dip recession in early 2012 and growth of just 0.3% for the year as a whole.

An economy that suffered as big a collapse as that in the UK would normally bounce back quickly and strongly. The dependence of the UK on debt-driven growth in the financial and housing sectors has been brutally exposed, as has the impact of high inflation in an era when wages have been depressed.

Concern number three is that the public finances are in a terrible mess. The IFS calculates that since the financial crisis and recession began, a £114bn black hole has opened up, and because of the slowdown in the economy this is £23bn bigger than estimated at the time of the 2011 March budget. By 2016-17, borrowing will be £24bn – not much different from Alistair Darling’s forecast in his last budget, despite the austerity measures introduced by the coalition. Faced with weakening activity, Osborne has been running to stand still.

Concern number four is that the planned squeeze is unprecedented. The IFS delved into the record books to see whether there was anything comparable in the UK’s history. There wasn’t. They then looked at the records kept by the Organisation for Economic Co-operation and Development in Paris to see if this sort of austerity had been tried anywhere else. With the possible exception of a three-year period of retrenchment in Ireland in the late 1980s, there hadn’t. The IFS, in the light of that, wonders whether Osborne’s plans are deliverable, particularly since the real pain is yet to begin on the spending side. While 73% of the tax increases have already come into force, only a third of the cuts in investment spending, 12% of the benefit reductions and 6% of the planned fall in non-investment public spending have taken effect.

Concern number five is that things could turn out to be even worse than this. The baseline IFS/Oxford Economics forecasts are based on the assumption that the eurozone sorts out its problems. In the event of a break-up involving the five most vulnerable countries – Greece, Portugal, Ireland, Spain and Italy – the UK would be plunged back into a second deep recession within five years. John Walker of Oxford Economics described that prospect as “challenging”. He added: “By that we mean ‘absolutely awful’.”

How will Osborne react to this? The IFS suggest that he should say publicly what he will do if the economic outlook deteriorates significantly, and that is sage advice. Keeping to the current plans with the economy crash-diving into recession would be economic suicide. On the immediate budget decision, the IFS was more equivocal. On the one hand it said the case for a fiscal boost was much stronger than a year ago. On the other, it noted that the government has to sell the thick end of £750bn of gilts over the next five years, so it needs to keep the financial markets sweet.

Osborne’s inclination is for the Bank of England to use quantitative easing to underpin growth and would find a U-turn in next month’s budget uncomfortable. But he has already been forced to downgrade his expectations in each budget and autumn statement since the election, and if the outlook continues to worsen he will eventually have no choice. © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds