March 3,2004

My authorities are most grateful to staff for an interesting and high quality set of papers, and will take careful note of their comments.

Economic prospects

The economic fundamentals in the UK remain sound: 45 consecutive quarters of growth, the longest unbroken expansion on record; growth in 2003¹ of 2.3%; inflation at 1.4%, interest rates at 4%, and employment at record levels of over 74%. With a strengthening global economy, growth is forecast (in the 2003 Pre-Budget Report) to be 3% to 3½% in 2004 and 2005; and inflation is expected to remain at, or close to, target. As staff note, there are risks: my authorities remain vigilant to these and agree with staff on the need for cautious macroeconomic polices, to which they are fully committed.

Policy framework

My authorities will continue to set policy on the basis of the policy framework established in 1997, and based on the principles of transparency, responsibility and accountability:

• Fiscal policy set according to two fiscal rules:

  • the Golden Rule—over the cycle, the Government will borrow only to invest;

  • the Sustainable Investment Rule—over the cycle, public sector net debt will be held at a stable and prudent level, defined as 40% or less;

• Monetary policy set by the Bank of England’s Monetary Policy Committee (MPC) to meet a symmetric inflation target.

As staff note, the inflation target has been recalibrated to 2% on the harmonized consumer price index definition. My authorities agree that this is unlikely to have material implications for monetary policy, and are confident that the reasons for, and implications of, the change have been well communicated and are widely understood in the markets, and more broadly. The MPC will remain vigilant and forward-looking to ensure that inflation remains at or near target at all times.

Fiscal policy

Staff recommend a gradual and predictable strengthening of the fiscal position; a slower rate of growth of public expenditure; and close monitoring of fiscal developments, including corrective actions if needed.

My authorities note that the fiscal rules are widely understood by markets and others as the guiding principles of fiscal policy, and have proved very successful in anchoring expectations. The credibility of this framework is key. My authorities will meet the fiscal rules, and – building on the platform established since 1997, with public sector net debt falling from 44% in 1996-97 to 33% in 2003-04 – they will entrench not relax their fiscal discipline. And they have announced that the rate of spending growth in the next spending round (this summer) will be lower than in this round.

Fiscal policy will, as usual, be set in the Budget. The latest available projections (in the Pre-Budget Report) show a gradual reduction in the deficit to 1⅓ of GDP; with an average annual surplus on the current budget of 0.2% over the cycle; and net debt stabilising at 35½% of GDP. My authorities are thus on track to meet the fiscal rules.

Staff see downside risks to the revenue projections. My authorities are confident about these projections and note that they are based on deliberately cautious assumptions (e.g. growth at the lower end of the forecast range, and trend growth 0.25% below the neutral view). Furthermore, they note that financial sector incomes are recovering rapidly, suggesting a rebound in tax revenues.

Structural issues

Staff have rightly noted the legacy of under-investment in public services. Public sector net investment fell by 15% annually in real terms between 1991-92 and 1996-97 leaving the UK with the lowest level of public investment of any large EU country. To address this, and recognising the importance of public sector infrastructure for private sector productivity, my authorities aim to raise public sector net investment to 2½% of GDP by 2007-08.

The key issue, however, is not the level of spending but the quality of the public services delivered. My authorities agree with staff on the need to improve efficiency and effectiveness, and have set out a broad agenda for reform, based on five principles:

• clear, measurable, long-term goals, that focus service providers on the outcomes the authorities seek to achieve;

• independent audit and inspection (separating responsibility for setting and monitoring targets);

• maximum local flexibility and discretion to innovate (with additional freedoms and flexibilities as performance improves);

• transparency (through monitoring and reporting publicly against targets, including local and national comparisons).

• efficiency (last year an independent review of efficiency in the public sector was commissioned, and initial work suggests substantial scope for efficiency savings: allocations in the 2004 spending review will be conditional on this).

With reforms based on these principles, and extra resources being channeled to the best performers, my authorities are determined to ensure value for money in public services.

My authorities agree with staff on the central importance of raising productivity, and have set out a comprehensive programme of microeconomic reform to remove the barriers that prevent markets from functioning efficiently. These measures aim to improve competition, promote enterprise, support science and innovation, raise skills and encourage investment; and they are regularly monitored and assessed.

On membership of the single currency, my authorities published their assessment of the five economic tests in June 2003. They concluded that a clear and unambiguous case for UK membership had not been made and that a decision to join at that time would not be in the national economic interest. The assessment set out a reform agenda to promote convergence and flexibility. Next month’s Budget will report on progress on the issues identified, to determine whether a further assessment of the five tests should be undertaken this year. My authorities are grateful for the staff’s analysis in the Selected Issues paper, and will study their comments carefully.

My authorities agree with staffs overall assessment of the UK financial system.

Other issues

My authorities will continue to support trade liberalization, progress under the Doha round, and CAP reform. They will increase ODA to 0.4% of GDP in 2005-06, and are committed to the target of 0.7%. They are seeking international agreement on a doubling of global aid flows through their proposal for an International Finance Facility.