Byline: Andrew Goodwin Senior economic adviser to the Ernst & Young ITEM Club
WHEN the Chancellor takes to the floor tomorrow lunchtime, he will have a difficult juggling act to perform.
On the one hand, he needs to produce a clear plan to get the public finances back on track. Yet in doing this, he must be careful not to derail a recovery that is in its early stages and remains fragile and prone to relapse.
The UK's fiscal reputation is on notice. Already Standard & Poor's and Fitch have warned that the UK could lose its AAA status because of the spiralling public sector debt, and the Chancellor needs to demonstrate a clear strategy for remedying this.
But timing is crucial -- reining in fiscal policy before the recovery has moved on to a firm footing risks tipping the economy back into recession. The example of Japan in the 1990s, where premature and overly aggressive fiscal tightening pulled the economy into a double-dip recession and the infamous "lost decade", should serve as a stark warning to the Chancellor of the risks of applying the squeeze too soon.
Officially, the UK economy remains in recession, the only country in the G20 in this unenviable position. Yet it is also the only country planning to begin withdrawing its stimulus at the start of 2010; most other governments plan to continue supporting their economies next year. Withdrawing the fiscal stimulus this early represents a huge risk, even more so given that there is no room to loosen monetary policy to offset the negative effects of tighter fiscal policy.
We would like to see the Chancellor announce a temporary extension to those measures -- such as the VAT reduction, stamp duty holiday, car scrappage scheme and first-year capital allowances -- which are already in place to provide support but which are due to expire soon. With smaller companies still finding it difficult to access finance we would also hope to see some targeted help for them.
Providing that such a package were accompanied by a clear commitment to reverse them as soon as the recovery has become entrenched, it would not have a significant impact on the efforts to regain control over the public finances.
As well as securing the recovery in the short term, we hope to see the Chancellor use the Pre-Budget Report as an opportunity to set out his vision for putting the public finances on a more sustainable footing over the medium term. …