Brown needs to find a steady course

THE PROSPECTS facing Gordon Brown have changed dramatically for the worse since he gave his first Pre-Budget report a year ago. Then, he was fresh from the glow of a Budget that had raised taxes for spending on the New Deal for jobs and basked in widespread praise for his surprise decision to make the Bank of England independent. The economy was entering a period of boom, with unemployment falling rapidly and consumer confidence hitting new peaks.

Now, the Chancellor has been bitterly criticised for that same decision to give the Bank the power to set interest rates, and for an economy that is slowing rapidly and may see dole queues start to grow. To cap it all, there is a global financial crisis going on in the background.

It is no wonder, then, that the Treasury has chosen to start a report on economic stability published this morning with the following quotation from John Maynard Keynes. In the turbulent year of 1923 he wrote: "Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again."

In other words, Mr Brown's task is to tell us today exactly how he plans to steer through all of this turbulence. It is no easy task: as the chart shows, the UK has been more prone to boom and bust than any other leading economy apart from Canada.

There are two key questions in the current macro-economic policy debate. Should interest rates be falling faster, and is the slowdown going to topple into full-blown recession and torpedo the Government's "prudent" and "cautious" tax and spending plans?

While there is no doubt that the Chancellor's advisers hope interest rates are on a firm downward path, the new report, "Delivering Economic Stability", mounts a staunch defence of the Bank's Monetary Policy Committee. If rates do turn out to have peaked at 7.5 per cent, this will be half their peak in the last business cycle, and they will have climbed just 2.25 percentage points from their low point. The Treasury puts it: "Policy is acting earlier, more decisively and in a more forward-looking way."

And as Mr Brown pointed out in his speech to the CBI yesterday, this means long-term interest rates, which matter more to business, have fallen to their lowest level for 35 years, even though the Bank has only just started to reverse its increases in short-term interest rates since May, 1997.

By contrast, in 1989 interest rates reached 15 per cent, 7.5 points above their May 1988 low. During the Lawson boom, the Government did not even start to tighten monetary policy until two years after the economy had passed the level of output corresponding to its long-term, non-inflationary potential.

The Treasury report emphasises, in the face of protests from unions and manufacturers alike, the need to keep the interest rate decision focused on low inflation and insulated from short-term political considerations. Its subtext is that if Kenneth Clarke had raised rates in the run-up to the General Election rather than generating a boom for electoral reasons, they could have started falling even earlier.

The other message the Chancellor will offer in today's statement is that his plans for Government borrowing are robust to the economic downturn. The Treasury is slashing its growth forecast for next year to "around 1 per cent".

As a result of the downturn in growth, the figures published this afternoon will be higher than the last set of forecasts for borrowing. Mr Brown's famous prudence does not mean that he will prevent borrowing from expanding to preserve spending on key areas such as health and education as the economy weakens. But he will not breach the so-called "golden rule" which states that over the course of the business cycle, borrowing will not exceed public sector investment - or so he will insist.

This claim is just as controversial as the view that interest rates have been set at about the right level. A new forecast from the respected National Institute of Economic and Social Research contradicts it. It warns that on current spending plans and the likely growth in tax revenues, the Government will have to borrow pounds 23bn more than it should under the golden rule between 1997 and 2001.

Puzzlingly, the contrasting views on the Government's finances are based on pretty similar forecasts for economic growth. It appears to be far more pessimistic than the Treasury's experts on the outlook for company profits and therefore corporate tax revenues.

History is on the side of the pessimists. In every past recession the government borrowing requirement has soared, and official forecasts have often turned out to be hopelessly optimistic. The Treasury itself conceded in its June report on the economy that the margin for error in terms of meeting the golden rule over the cycle was "limited".

But today's new report suggests that history is no guide to future performance. Just as monetary policy has reacted faster, so has fiscal policy, with a much tighter fiscal stance in the past year. This means that the Government deficit, adjusted for the stage of the business cycle, is close to zero. It should allow more scope for looser policy - that is, higher borowing - as growth slows.

It claims, in other words, that the Government is already on the way to achieving greater stability for the British economy. This business cycle is likely to be less pronounced on the way down, as it was on the way up, compared to previous episodes of boom and bust.

Some economists, of course, reckon prospects are much grimmer than the 1 per cent growth prophesied by the Treasury for 1999. The Chancellor's claim to have already started to deliver greater stability will not be fully tested until the economy has got past this particular patch of stormy water and reached the calm ocean beyond.