§ I come now to the public sector finances.
§ Over the 1980s, my predecessors transformed our public finances and made them the envy of fellow Finance Ministers throughout the world. They first reduced and then eliminated our budget deficit, and in the last three years they repaid £26 billion of debt. The ratio of public sector debt to gross domestic product has been reduced from 50 per cent. in 1979 to under 30 per cent. now, to the benefit of this and future generations.
§ I am not going to fritter that legacy away. The firm control of public expenditure remains at the centre of our strategy. I will continue to aim for budget balance in the medium term. It is a simple rule, which is well understood and requires the Government to finance their spending honestly.
168§ Our entry into the ERM does not alter the requirement for fiscal policy to buttress monetary policy and play its part in curbing inflation; so sound public finances will remain central to our strategy for the 1990s.
§ However, it is one of the more reliable laws of economics—not that there are so many—that the budget balance varies markedly over the economic cycle. When activity is growing strongly, tax revenues rise relative to income, and lower unemployment brings lower social security payments. We saw this in operation in the late 1980s when we ran large budget surpluses.
§ Those forces go into reverse when the economy slows down. That is why the Budget surplus has shrunk over the past two years, and why we are now likely to see the temporary re-emergence of a public sector borrowing requirement.
§ Those cyclical swings in the budget balance can play a useful role in offsetting the swings in private sector borrowing, and in stabilising the economy. They come about automatically, without the need for difficult judgments about the state of the economy. It is entirely consistent with the medium-term approach that I have already outlined to tolerate those swings in the fiscal position, but I am not persuaded of the case for going beyond that.
§ In 1990–91, the Government's finances have been affected both by the onset of the recession and by the Gulf war. However, as a result of the assistance we have received from our allies, the net effect of the war on the PSBR has not been as great as we feared. The outturn on the public expenditure planning total is expected to be a little lower than we forecast in the autumn statement. Overall, despite the war, I expect to achieve a further debt repayment this year of approaching £1 billion.
§ For the year ahead, I judge that a deficit of £8 billion can fairly reflect the strength of cyclical influences. For the same reason, I think it will be right to tolerate a somewhat larger deficit in 1992–93, for it takes time for the effects of lower activity to feed through fully on to revenue. The most notable is corporation tax, which is both highly sensitive to the economic cycle and paid in arrears.
§ Those deficits will disappear once output has returned to normal levels—just as the surpluses of the late 1980s did. Prudence dictates that I base my fiscal plans on a gradual recovery in output to its long-term trend. This implies a correspondingly gradual return to budget balance, but in practice the speed with which this happens will depend on the exact course of the upturn.
§ To summarise: for the year ahead, I am budgeting for a PSBR of £8 billion, 1¼ per cent. of GDP, and I expect a somewhat larger deficit in the following year. These deficits reflect the effect of lower activity on the public finances and are fully consistent with the aim of a balanced budget over the economic cycle.
§ In order to hold to this prudent fiscal stance, my Budget today will have a broadly neutral effect in the coming year, but will produce a modest increase in revenue in 1992–93.