Erich Arispe and Stephen D King.

Q178 The Chair: Good afternoon and welcome to this hearing of the Economic Affairs Committee: how sustainable is our national debt? A very warm welcome to our two witnesses. Would you like to introduce yourselves formally for the committee, please?

Erich Arispe: Good afternoon. I am a senior director in the sovereign team at Fitch Ratings and the lead analyst for the UK.

Stephen D King: I am a senior economic adviser at HSBC and the author of some books.

Q179 The Chair: That is very modest. Thank you both again for coming in. I very much look forward to the next couple of hours. Let me start by asking a very general question. Does debt matter? I ask because we have had some evidence from certain quarters saying debt does not really matter. I will give you one quote. “The UK Government does not have a national debt”, some say. Some claim that the level of debt is vastly exaggerated. Does debt matter? Stephen, can I ask you just to set a frame around what we are thinking of?

Stephen D King: I will try. Yes, it does matter. It has all sorts of implications depending on how quickly it is rising, who is indebted, what the returns are on the money that is raised, in terms of long-term investment, and the financial stability or otherwise of a particular country. If we think about people who might argue that debt does not matter at all, thinking particularly of government debt, there are a number of problems with that.

If you have rapidly rising government debt and you are running out of political space, for example, either to raise taxes or to cut public spending, something else is likely to have to give. One possibility is financial repression, which is a distortion of how you allocate capital within the economy. Another possibility is that you can default, but most Governments will not default if they can possibly avoid it. The third possibility is that Governments will be tempted to create inflation, because, if unanticipated, inflation will generally redistribute the costs from debtors to creditors. Effectively, inflation in that sense works as a wealth tax. It hits those who have cash savings in particular, but the Government in the short term might benefit because of the fact that in real terms their debts will then begin to come down.

I would also note that you can do a thought experiment between Greece within the eurozone and the UK outside the eurozone. The UK is in a position that the proponents of modern monetary theory would say gives it flexibility in a way that Greece does not have flexibility. In other words, Greece does not have access to a printing press and therefore, if things become troublesome for it, there is a significant risk of default, which is exactly what happened during the eurozone crisis. In the case of the UK, admittedly it can print money to deal with the problem, but printing money comes with its own potential costs.

The first one I have already mentioned, which is inflation. The second is the possibility that the exchange rate falls quite a long way. In fact, the two of them are not inconsistent with each other. You could quite happily have a situation where the exchange rate falls and inflation picks up. In fact, the UK in the mid-1970s is probably a very good example of that story. At the very extreme, if the public lost confidence in the monetary and fiscal institutions because there was a sense that, whatever happened in terms of debt, there was continuous printing of money, the Government or the central bank would quickly discover it was not the only issuer of currency.

To give an example, in the 1980s, Israel had massive hyperinflation. The shekel was falling in value incredibly quickly. Through no choice of the Israeli Government at the time, you could reasonably say that the Israeli economy became entirely dollarised. The people effectively stopped using the currency altogether. From my perspective, there are considerable costs associated with not taking debt seriously. Those costs are not to be underestimated.

Erich Arispe: I should say that my answers will come from the perspective of a ratings agency and are in relation to the sovereign rating or the creditworthiness of the UK sovereign. This is a forward-looking assessment of the capacity and willingness of a sovereign to service its debt obligations in a timely manner and according to the original terms. This assessment is based on published sovereign rating criteria.

For context to set where we see the UK credit rating at the moment, the current rating is at the AA-minus level. This is three notches below AAA, which is the highest rating possible. At AAA you can find sovereigns such as Norway and Germany. The US now sits at AA-plus. We have France and Belgium at AA-minus.

To answer your question, yes, debt matters. In the case of the UK, two of the key credit weaknesses are related to debt. They are the high level of debt and the high cost of debt in terms of rising interest payments. One of the key long-standing strengths of the UK has been the policy credibility of the overall framework. This is related to the question and some of the thoughts that Stephen provided on how to address the problem of debt through unconventional means.

For us, the risk is not only of failing to address the high debt level of the UK currently, but of this leading to the weakening of this track record of policy credibility, especially in an era where it has become very apparent that it is important to maintain credibility to address shocks that lead to higher inflation, as well as to have the fiscal space or policy space necessary to provide a policy response.

Just to finalise and illustrate the point, it is important to go back to the mini-Budget episode of September 2022. We had a situation where a mix of unfunded cuts and rising inflating led to a market perception of weakening of the policy framework and increased policy uncertainty, which in turn led to an increase in macro financial instability risks.

Chair: Thank you both very much for setting the scene.

Q180 Lord Davies of Brixton: The question, “Does debt matter?”, is asked widely. What is not asked so widely is whether assets matter. There is always a counterparty. Is it a zero-sum game between debtors and holders of debt? Is there some play-off that means that we can lose out overall?

Stephen D King: Could I give you a private sector rather than public sector response? It takes you away from the specifics of government debt and it looks at debt in general. In the late 1990s, during the Nasdaq technology bubble in the US, one of the defences for why the bubble was not a bubble was the fact that, although debts were rising quickly, the value of assets was rising even more quickly, at least on paper. The equity price bubble effectively justified higher and higher levels of debt. The higher levels of debt were entirely sustainable from the balance sheet perspective, so long as the assets themselves were rising in value.

It turned out that the assets were rising beyond what you might describe as fair value. There was a big debate in the late 1990s as to what the fair value was going to be. There was no doubt that the markets had begun to believe, falsely, that the US economy could continue to grow in real terms at maybe 3% or 4% a year into perpetuity and that this could be justified with interest rates that were much lower than they had been in the past.

When the Federal Reserve was eventually forced to raise interest rates to try to slow the economy down and put the brakes on it, two things happened. First, there was a higher discount rate now attached to the future earnings of all these companies that were supposedly miraculous. Secondly, by putting on the brakes, the future earnings themselves were now expected to be lower than they had been previously. They had this twin hit of a higher discount rate and lower than expected future earnings. That triggered the huge decline in asset prices that we saw in 2000 and beyond. As asset prices fell, debts that had previously been digestible became indigestible.

The issue here is not so much whether at any time the debts are backed by a particular asset. It is the fact that the asset is only worth what it is worth on the basis of a forecast for the future. That forecast itself can change quite radically, as we discovered in the late 1990s and the beginning of the 21st century.

Lord Davies of Brixton: Does that work with sovereign debt?

Stephen D King: In one sense, it is even trickier because the problem with sovereign debt is that, if you have a balance sheet approach that says we should value the nation’s assets alongside the nation’s liabilities, from an accountancy perspective that is absolutely fine. I am not suggesting you cannot trust politicians in general. Of course you can, but the temptation to claim the assets are worth more than they really are worth would be extremely high. It would make it easier in one sense to justify a level of borrowing based on the idea that assets were worth X, when in fact they were worth significantly less than X. You would then lose some of the discipline you probably need to make sure that your fiscal numbers properly add up over the long term.

Lord Davies of Brixton: It is the indiscipline that is the problem rather than the debt.

Stephen D King: Any given level of debt is not a problem. The indiscipline comes from the fact that, if the debt continuously rises over time, you are making a bigger and bigger bet about the beauties of the future, because you hoped to repay or to service that debt, and making assumptions about whether that future is going to be good or bad.

To take another example, three or four years ago, when many people argued that the western world was going down a Japanese-type path, you could reasonably say, “On the basis of that idea, interest rates are going to be at zero for evermore”. If they are at zero for evermore, it is perfectly reasonable to have much higher levels of debt than was the case previously, because the debt service costs are not rising as quickly. That still is a forecast that interest rates will be at zero for evermore.

What we discovered over the last two or three years is that that forecast was unreliable. We did not know where rates would be in two or three years’ time, but nevertheless the idea that they were going to be at zero permanently was, for me, and certainly in hindsight, an error that many people made. It was easy to be consumed by that error and it was a very attractive assumption to make for Governments in particular, because they could borrow quite happily over an extended period.

Chair: I will move on to Baroness Wolf, because that is a nice segue.

Q181 Baroness Wolf of Dulwich: That does fit quite nicely, because this is asking you to do a bit of crystal ball gazing and forecasting. This is for both of you, but I will start with Stephen, taking off what you have just been saying. Are you worried by the current public debt trajectories, first in the UK and secondly more generally across the G7?

Stephen D King: The short answer is yes. You know this already, but, if you think historically, UK Government debt has risen at this pace and at this level only during wartime, through sustained wars during the 18th century, leading up to the Napoleonic Wars, and then through the First and Second World Wars. Typically, beyond those periods, debt is possibly high at times but falling. That has been very much the story of the second half of the 20th century.

At least in the UK’s case, this is the first time in peacetime that we have seen debt rising as far as it has done. Moreover, this is before you get all these issues coming in over the next 30 or 40 years. It is before you get the really big demographic hit, the full cost of the green transition and the cost of building up defence. Already, we are in a relatively weak position.

If I may say so, one of the problems here is that we have a commitment to various levels of public service and to various levels of taxation, which does not sit comfortably with how the UK economy has performed over the last 20 years. I would like to give some numbers on this. If you go back over the last 60 years and look at the increases in real per capita GDP decade by decade, it helps to illustrate the point of why life is so much more difficult fiscally than it was previously. From 1967 to 1973, there was an increase in per capita GDP of 36%. From 1973 to 1983, which was a bit of a miserable time, there was an increase of 13%. Then it was 26% between 1983 and 1993, and 31% between 1993 and 2003. In the last 20 years, and these are quite extraordinary numbers, it was 5% and 8%. The pace of expansion is so much weaker than it previously was.

Even the OBR at the moment is still assuming that long-term growth will pick up to maybe an average of 1.5% or so per capita per year, which is about double what it has been over the last 20 years or so. But, if you have persistently weak economic activity, you are then faced with persistently weak revenues relative to your plans. You are faced with commitments you have already made in terms of public spending that are more difficult to achieve because the economy is so much smaller than you had hoped it would be.

For me, the problem that both major political parties face is that it is quite difficult to admit to the public that this is the scale of the problem that currently exists. It is easier to pretend that economic growth will simply rebound to something faster over the next two or three decades.

If you look at reasons why growth has slowed down, I will turn it on its head. You have to look at the reasons why growth was so rapid between the 1950s and the 1990s, because it was extraordinarily rapid over that period.

Baroness Wolf of Dulwich: Could I push you on the rest of the G7, just in terms of their current debt trajectories?

Erich Arispe: Based on our assessment and from a creditworthiness perspective, the high and rising level of public debt in G7 economies represents a source of pressure on ratings. You just have to look at last year when we downgraded the United States, reflecting the rising debt level as a result of the wide fiscal imbalances, as well as the downgrade of France to its current level of AA-minus, which also reflects the continued increase in government debt.

We acknowledge that developed markets can sustain higher levels of debt because of the depth of the capital markets and reserve currency status in some cases. Nevertheless, echoing Stephen’s comments, we now have debt levels that are a legacy of successive shocks. We have the pandemic. We have the war in Ukraine. If we go a little bit further into the past, there is still a high impact from the global financial crisis and the step-up in debt for G7 economies.

When we look at the UK from a rating perspective, we compare it to countries with a similar rating. If we look at an estimation for the UK general government debt level for the end of 2023, that is close to 101% of GDP. This compares to an estimated median for AA-rated economies of 56%. It is significantly higher. If we look at the increase in UK general government debt from a pre-pandemic starting point of 2019 up to last year, it is about 15 percentage points. It is one of the highest among G7 economies, followed by France, then the US. I would provide a caveat of looking at debt from the prism of G7 economies. From a creditworthiness perspective, G7 economies have different ratings. Those ratings may reflect that some economies have higher debt levels. From our perspective, it is probably not very useful.

Baroness Wolf of Dulwich: The trajectories you feel are worrying for all of them.

Erich Arispe: I would not characterise that as worrying. As a rating agency, we apply the methodology we have to the trends and see what implications that has for the ratings. Certainly, it represents a source of pressure on their current ratings.

Baroness Wolf of Dulwich: Could I follow this up by looking at the past? Clearly, you are right that the thing about the past was that we had high growth, and why did we? Does it offer any useful insights into the likely path of the UK’s debt ratio over the next decade, other than saying it would be really nice if we could grow again?

Stephen D King: It would be really nice if we could grow again. It is worth stressing that in the 1950s and 1960s many countries dealt with initially high levels of debt through a combination of strong growth, because it was pretty strong, with some level of financial repression. Interest rates would be lower than growth rates. Savers would be penalised a certain degree. It is worth stressing that financial repression is much easier to deliver if you have capital controls or exchange controls. Unless anyone is advocating a return to that, and I do not think most people are, it is quite difficult to make financial repression as effective as it might have been back in the 1950s and 1960s.

I agree with Erich that the problem with the growth story is that a series of shocks have come through, which have depressed growth to a certain degree. I would also argue that there were other shocks, which were very positive, that came through from the 1950s to the 1990s. We assume that these things are still with us, when in fact they are probably not, or at least not to the same degree.

The first of the positive shocks was the opening up of world trade and world capital markets, through a radical shift away from the protectionism and isolationism of the interwar period. The second factor was the participation of women in the workforce, which changed dramatically, partly through legislation and partly because of labour-saving devices at home, frankly.

The third was the huge extension in tertiary education. Very few people in the 1950s went to university. That has changed radically over the last 50 or 60 years, probably, I am afraid to say, with diminishing marginal returns. The fourth was a huge expansion of consumer credit, which allowed savings ratios around the western world to come down dramatically, but particularly post global financial crisis it has been more difficult to deliver that.

Then the fifth and most obvious one is the boomers, travelling through and expanding the size of the working age population, then going into retirement or less active work. There was a report I wrote 20 years ago, which had a rather depressing conclusion that the peak growth rate for economies was typically when life expectancy was around 65 or 70, because that had the convenient result of people working, then dropping dead and not becoming a burden on the state or society in general.

Unfortunately—well, it was not unfortunate; it was great for everyone—in terms of economic effects, when you have a significant increase in life expectancy relative to a barely shifting retirement age, you are likely to end up with resources devoted to things that do not give you such a high rate of economic growth. That is another big change that has come through in the last 20 years or so.

Baroness Wolf of Dulwich: You do not have any other wonderful pluses to offer that we have not exploited yet.

Stephen D King: There is one I will mention, because I know from your previous hearings that you talked quite a lot about demographics. It is something we know a lot about, but, as a consequence, we may put too much emphasis on demographics and not focus on other things that might be influences on economic growth.

There is a paper that Greg Mankiw, the second President Bush’s economic adviser, and David Weil wrote in 1989 called The Baby Boom, the Baby Bust, and the Housing Market. It predicted that there would be sustained declines in house prices in the US in the 1990s on the back of demographic trends. It is probably one of the worst forecasts ever made, but it was based on the fact that the demographic story appeared to point in that direction. It turned out that they were not putting enough emphasis on other factors that were more positive.

If you are being positive for the future, one thing you might focus on is AI. It is pretty amorphous in terms of its effect, but if you were to tell the story of the next 50 or 60 years and say, “It was better than we had expected”, my guess would be that AI might play a role in that.

Baroness Wolf of Dulwich: Finally, can I follow up and perhaps ask Erich this first? You have factors that are pushing debt up and factors that will make it more or less sustainable. Which of the variables in play do you think poses the greatest risk to the UK’s public finances, in the short and the longer term?

Erich Arispe: From our perspective, it is a combination of low growth prospects and the prospect that we are going to have higher interest rates than we had before the pandemic. The periods where we had ultra-low or negative interest rates to finance a higher debt burden are probably behind us. Then we are facing this challenge, not only in the UK but for policymakers across the world, of how to generate growth, especially in advanced economies that face the headwinds of a changing demographic profile, as well as more global trends. Stephen talked about what is happening now with trade and financial integration. It will probably be a little bit of a reverse of the process we saw after the 1950s. This challenge of growth is going to present a problem, in the new environment of higher rates, in trying to bring debt under control.

We know that five-year growth for the UK before the pandemic was about 2%. Now we are going into a period where growth is going to be below 1% for both 2023 and 2024, with a short-lived and probably very mild recession in between. When the economy recovers in 2025, we see growth going up to 1.8% and probably averaging 1.6% or 1.7% in the following years. We can argue about how close or how far that is from the potential growth of the economy. None the less, at least based on our scenario, these projections are insufficient to bring down debt. In fact, we have debt increasing gradually to about 107% of GDP by 2027.

Q182 Lord Londesborough: Erich, I would like to follow up on Fitch’s rating of UK sovereign debt. I should just declare an interest, in that I was a non-exec adviser to Fitch from 2014 to 2016. To recap, Fitch affirmed its rating at AA-minus in December but with a negative outlook, whereas the other two agencies, S&P and Moody’s, dropped their negative outlook about nine months ago. I am interested as to how and why Fitch differs from the other two.

Erich Arispe: The negative outlook reflects our sense that there is still significant uncertainty regarding the path or feasibility of fiscal consolidation. That is amid the still volatile macroeconomic outlook, the risk of persisting high inflation, as well as the proximity of the next general election. They create some challenges with getting more information and reducing uncertainty about the future path of fiscal policy. As we can probably all agree, fiscal plans are more credible when they are done over the medium term. Nobody expects debt to come down from one year to another. In fact, that might be counterproductive. For us, it is important to get more certainty, clarity or information about what the path for fiscal consolidation may be.

There are some lingering questions about what the fiscal policy will be before the election. We will get some answers in the next few days with the spring Budget. There is also uncertainty regarding what the policies will be in the next Parliament, in order to address the debt issue, as well as some other lingering fiscal responsibilities. There is also uncertainty about what the political space will be, in order to implement some of the fiscal measures that are outlined in the current fiscal strategy, if that is sustained in the next Parliament, to bring down debt. Given all those factors, we cannot point to a situation where we see debt stabilising or slightly declining over the medium term.

Lord Londesborough: This key issue of policy credibility is not helped by the fact that we are in an election year. There is the political temptation to loosen the strings in the months coming up to an election. That is a particular concern that will influence your negative outlook, is it?

Erich Arispe: In general terms, when you look across other sovereigns at different levels of development, elections always represent a challenge, not only because of what can be done before the election, but also in trying to anticipate or get a better sense of what the policy response may be to a specific macroeconomic or public finances challenge.

In the case of the UK, we have seen that the starting point of the fiscal consolidation trajectory under the current fiscal strategy is better than what we anticipated at the end of 2022, for instance. Back then, we were thinking about the impact of the energy crisis. How much support would the Government have to provide to households and companies over the extended period of a potentially disruptive supply shock derived from the war in Ukraine?

When we move to the spring of 2023, that worst-case scenario had abated to a certain extent. The Government did not have to spend or support the economy to that extent. Growth proved to be more resilient, although still weak. Although it remains stubborn, inflation has come down in recent months. Overall, we have to look not only at the uncertainty of the political process, but also at the starting point. Based on the scenario we had at the end of 2022, the starting point is better.

Q183 Lord Griffiths of Fforestfach: So far, we have looked at the issue of trajectories for public sector debt. If you go back and look at the UK, we have had serious inflation twice since the Second World War. The first one was appalling economic policy from the Government in 1971, 1972, 1973 and so on. It was also tied to the introduction of competition, credit control and floating exchange rates. Then you have the most recent one, which is Covid, Ukraine and now Gaza. It seems to me that the real danger is radical uncertainty. It could be the result of government changing the structure, or the result of war, pandemic or whatever else. I just wonder how you see the two.

Stephen D King: One answer is to say I am very uncertain about it. It is a shame that Lord King is not here, because he is one of the authors of radical uncertainty. Can I go back a few years? It seems to me that, during the period of quantitative easing, across much of the western developed world that used QE there was a sense that Governments could do anything because there was no cost. The cost was effectively absorbed or mopped up by the actions of QE, which kept bond yields lower than they otherwise would be. To that extent, if the bond market vigilantes of old were doing something, they were no longer doing it with government bonds. They were looking elsewhere in terms of how they would speculate and think about judgments of economic sustainability.

Now that QE has broadly ended, if only temporarily, and you have QT coming in in different countries, that coincides with the fact that bond yields themselves have risen significantly. There was a feeling for many years that we were just like Japan. Japan would be a story of lowish growth and high levels of government debt, which were sustainable because debt services costs were incredibly low, partly because of the actions of the Bank of Japan in offering yield curve control and all these kinds of things.

Two things have changed. First, it turns out that what was true of Japan for 30 years has not been so true for other countries, to the extent that interest rates now have gone up quite a long way. They have gone up across the yield curve. It is not just short-term interest rates that have gone up; long-term interest rates have gone up as well. The second thing that has happened, which has not had much discussion, is that Japan itself has a bit of a problem currently. We do not know the scale of the problem, but inflation has picked up a little bit, which the Bank of Japan and others would say is very desirable, but it is now above target rather than below target. It is not very far above target, but it is above target.

The really big change in Japan is the exchange rate. Where 11 or 12 years ago a dollar would buy you 80 yen, it now buys you 150 yen. You could argue that, by Japan not choosing to raise interest rates when everyone else has, it has had a very big impact on the value of the yen, which in turn means there has been a very big redistributional effect within Japan itself. Put very simply, other things being equal, households and consumers are worse off because the terms of trade have significantly deteriorated. At the same time, because of the impact of very low interest rates, which had supported tremendous gains in the equity market after years and years of weakness, those who are financially sophisticated and have access to the stock market have done very well.

What is bothersome about that story is that, if it is true that QE distorted decisions from Governments and that Japan has some problems that it did not expect to have three or four years ago, it may equally suggest that other countries have problems too. The idea that the bond markets will be persistently patient with countries is not guaranteed. Some of the crowding out arguments of the 1970s and 1980s might return.

If you do not want that to happen, you can have what I describe as quantitative crowding out, which effectively is financial repression. For example, you can force banks to lend to the Government as opposed to anybody else, which may help the Government finances but does not help the broader economy. I would suggest that, having had this phony peace in terms of the relationship between monetary and fiscal policy and financial stability over the last 10 or 15 years, that is not guaranteed for the future.

Q184 Baroness Liddell of Coatdyke: There is a general election coming, as Lord Londesborough has pointed out. The OBR has told us that long-term debt sustainability requires action over that medium term. Let us say the Wicked Witch of the West comes in here and you are both the Chancellor. What would you do?

Erich Arispe: In our role as a ratings agency, we have no expectations regarding the future policy actions of Parliament or government. We are not that fond of playing the Wicked Witch of the West. I would just echo the comments regarding the reason why the negative outlook is present. It is more about the fiscal strategy and its feasibility, in terms of what happens after elections if the current strategy for fiscal consolidation is maintained, especially on the expenditure side. The cuts that are forecast to be implemented may be unfeasible or very difficult to implement post election. For us, the important thing is to see how the authorities will address this matter.

Stephen D King: To get elected, Governments are not going to promise austerity, most of the time. It seems to me that, if you look at the fiscal rules currently from both this Government and the prospective future Labour Government, they do not have any significant teeth at all, which is another way of saying that both Governments would simply allow debt to rise and hope it does not cause a problem. There is a fundamental political difficulty in the UK. I know other people have said this already. We aspire to European levels of public spending and public benefits, and we aspire to US levels of taxation. I am afraid the two do not sit together very easily.

There are things you can do in the short term to raise taxes. For example, you could have a big debate about whether there should be more taxes on wealth. That might be an easy way of raising revenue. I want to offer a caveat to that. The assumption effectively is that people with wealth have a relatively low marginal propensity to consume, so if you tax them it does not hurt the economy very much, and if you give the money away in benefits to other people who may have a higher marginal propensity to consume, in aggregate, demand will be higher. If demand is higher, but there has been no improvement in the supply side of the economy, all you end up with in those circumstances is probably the Bank of England setting interest rates at higher levels than would otherwise have been the case. There is still a cost associated with it.

This is another way of saying that the thing you really hope you could do, as the Kind Witch of the West, is to wave a magic wand and get faster economic growth. What is striking about the debate about debt, the fiscal position and so on comes back to my earlier comment, which is that there is not enough discussion about why growth rates are so low and what might be done about them. I am not saying it is easy in any way at all, but I would suggest that the UK has to think about this carefully, because the headwinds from the rest of the world are far greater than they would have been 20 or 30 years ago.

The Chair: How much time do we have to address this, Stephen? Is it the next Parliament, as Baroness Liddell was saying?

Stephen D King: As I understand it, the OBR is forced to effectively take the current Government’s four or five-year plans and plonk them into its numbers. It is fair to say that the OBR probably does not really believe those plans, and probably no one else believes those plans. The truth is that the situation will deteriorate sooner than is contained within the OBR’s projection, for the simple reason that the OBR is using numbers that have been given to it by the Government for the next four or five years, where the Government have not spelled out precisely how the spending cuts or revenue gains will be delivered. That lack of clarity suggests that there is a greater urgency.

The Chair: It is in the next Parliament.

Stephen D King: The problem with this, as I am sure Erich will agree, is that it is unclear when the costs will come through for this lack of sustainability. In an earlier hearing you had, there was a discussion about whether it would be a political choice to make these changes, or whether it is more likely to be a financial event that forces the changes. I would suggest that it is more likely at the moment to be a financial event.

Baroness Liddell of Coatdyke: Stephen, you have mentioned financial repression two or three times. How big a risk is that for this country?

Stephen D King: This comes back to options. If you decide that you cannot raise taxes very far, you cannot cut public spending and your debt situation is out of control, or at least your debt is rising rapidly over time, as I mentioned before the other options are default, financial repression, inflation and devaluation. None of them is attractive. Financial repression in the short run might seem to be the easier to deliver politically. The danger with it in the long run is that the financial institutions that would see their profits reduced as a consequence of financial repression might go elsewhere.

I should stress that I am not talking here on behalf of HSBC. Please do not take those words as a corporate view. It is not at all. I am just talking in general. Again, you come back to the fact that, if you do not have foreign exchange controls or capital controls, it is relatively easy for institutions to escape from regulations that are tough in one part of the world, but not so tough elsewhere.

The Chair: Erich, what do you think about Baroness Liddell’s questions, in terms of both timing and financial repression?

Erich Arispe: Given the policy direction outlined by both the Bank of England and the Treasury, in terms of bringing inflation under control and reducing the debt through traditional means, we do not see the risk in our baseline scenario. In terms of risk, for an economy such as the UK, I would echo the comments regarding this option creating challenges to the long-standing credibility of the overall policy framework. For an economy that is dependent on external financing, both overall as an economy and for financing a significant portion of debt—it is about 30% of the outstanding debt stock—in a world with increased financial integration, that may not be a viable option.

Q185 Lord Turnbull: We have had conflicting evidence about interest rates and their future course. There was a theory associated with the previous Governor that an excess of savings in the world would lead to low interest rates or possibly a return to lower interest rates.

We had contradictory evidence last week, from Charles Goodhart, that demography will probably take things in the other direction. The cohort of people who are saving most are probably the people who are just passing over the line between working and retirement, so there will be more dis-savers. He also thought that the way we had set out pensions and benefits discourage a certain amount of saving. He is thinking that interest rates are likely to stay high.

What is high? We have had some discussion about r - g. It is not a concept that the Treasury ever uses in any public documents, but lots of economists think in those terms. What is r? What is an equilibrium? Where does the threshold lie between regarding interest rates as lower than or higher than they will tend to be?

Stephen D King: I just wanted to say the OBR does use the r - g thing. It is not the Treasury, but the OBR, which is closely related, uses the concept. Charles Goodhart’s argument is only half the argument. He would not like me for saying this, probably. The reason for this is as follows. When you have an ageing population, your problem ultimately is that you have a lot of people who have built up savings through their lifetimes who now want to spend, but there are fewer people working than there were previously. Therefore, their savings somehow have to be reduced in value.

There are two ways in which that can happen. It depends partly on the nature of the savings. For example, if you have a mature population whose savings are mostly in the form of real and financial assets, to turn them into cash they have to sell those assets to the younger generation. If the younger generation is fewer in number, there is a risk that the value of those financial assets falls as part of the sale. If you have financial assets falling in value relative to a given level of debt, that can then spark a period of deleveraging, which leads to weak growth, very low inflation and very low interest rates. What I have described there is really the Japanese experience over the last 30 years or so. You had these tremendously elevated asset prices. In the process of trying to sell to younger generations, the asset prices fell. You had a lot of very low rates and very low inflation.

If, on the other hand, it turns out that your savings for the older generation are entirely in the form of cash, they do not have to make the sale. They have the cash there already. They tend to try to spend that cash, so the velocity of circulation of money goes up. Other things being equal, that will be inflationary and you have to set interest rates nominally at higher levels than was the case previously. That does not answer your question, but what it does say is that Charles Goodhart’s argument is half of the potential as opposed to all of it.

Lord Turnbull: Which way are you leaning?

Stephen D King: This is where you try to bring monetary and fiscal policy back together again. Having had this very substantial increase in government debt and having moved away from QE-type policies, with the perceived incentive that Governments or central banks might be more relaxed about inflation today than would have been the case five, 10 or 15 years ago, i.e. there is greater accommodation of inflation, my sense is that the debt dynamics will partly be dealt with through higher inflation, in which case you would probably end up with higher nominal interest rates in response to that.

That does not necessarily mean you get higher real rates. If you were accommodating the inflation, you would not necessarily have the higher real rates to put the brake on the economy. I would not be surprised if one way out of this is just to be more forgiving of inflation at a moderate rate than we have seen at any point over the last 15 years.

Lord Blackwell: If you look 10 or 15 years out, the bond markets are building in a long-term interest rate of 4%. Assuming inflation of 2% or 3%, this means a positive return of 1% or 2%. Is that reasonable?

Stephen D King: It is a scenario. I do not mean to be glib about this, but what I mean is that the bond markets are making a sum of probabilities at any particular time. If you go back five or six years, when bond yields were down at 1% or 1.5%, the view that the market had at that stage was fundamentally different from the view that it has today. This comes back to a greater flexibility in people’s views about inflation than there was five years ago. Five years ago, there was an obsession with the idea that deflation was the only game in town. We now have a more balanced position than we did back then. To that extent, yes, it is reasonable.

However, if you look at the long-run relationship between nominal GDP growth and levels of long-term interest rates, which theoretically should be relatively closely related with each other, the relationship is rubbish. It does not work very well, which tells you that the market might be perceiving risks that do not come to fruition, that there might be financial repression, or that there might be differences of view as to which kinds of assets you want at any particular time.

For example, it is likely that an ageing society will want to have more bond-like instruments than a younger society would, because you are trying to preserve your existing wealth rather than taking risks and growing your capital. For a younger society, you might be happier with owning stocks or equities that do not even pay a dividend, so long as you have the prospect of long-run capital growth. Microsoft is a famous example of this. It famously did not pay a dividend for years and years. It did not have to because the investors were not buying it for dividends. They were buying it purely for long-run capital growth.

The Chair: Erich, do you want to comment on any of those points from Lord Turnbull?

Erich Arispe: From a ratings agency perspective, we are on the more conservative or bearish side, in the sense that, over the past decade, we did not believe that very low or ultra-low yields were sustainable without central bank interventions. As a result, we expect it to be higher. Looking at our projections of what will happen to interest rates over the medium term, we will probably have a much more gradual pace of monetary easing than the market is pricing currently. Also, we believe that by the end of the decade we will probably have yields for US 10-year treasuries, for instance, at 100 to 150 basis points above the level of 2019. For us, it seems that Governments will face higher financing costs and tougher financing conditions.

Q186 Lord Layard: Could we look at the international scene a bit? What would you think are the main geopolitical risks to our debt sustainability?

Erich Arispe: Summarising some of the points already made by Stephen and restating the obvious, maybe, geopolitical and global economy events or trends right now are not going to be as favourable as they probably were for previous cycles, in which debt for developed economies came down. In terms of geopolitics, it is difficult to say. Right now, we have two live conflicts that have the potential to spill over and create ripple effects that go beyond just the regions where these are occurring. Hence the likelihood of these external shocks materialising is high, as we have learned in recent years. Geopolitical developments remain a source of uncertainty.

Another point mentioned earlier is what is happening with trade and financial integration, especially given the prospect of having two different blocs, meaning a US sphere of influence and a China sphere of influence, which can create headwinds for economies that are dependent on exports or global trade as well as financial integration.

On the economic side, in the near team at least, there are not many tailwinds for economies such as the UK. Now we have global growth that is likely to be weak, at about 2.1% in 2024, and the prospect of a rapid recovery from either the US or China remains uncertain, at least for 2025, especially given the challenge that China has in terms of domestic consumption, as well as what we expect to be a slowdown in the US economy. Overall, at least in the near term—it is very difficult to make a projection beyond that—the stars are not aligned on the external environment, from both the geopolitical and economic perspective.

Stephen D King: Can I just make a very simple observation? I remember, back in the 1980s, bond markets were all over the place relative to each other. Yields would vary dramatically. Some countries would have low yields and some high. Bond market vigilantes played a role in trying to work out which were the good guys, which were the bad guys and so on. Over the last 20 or 30 years, you have seen enormous conversions of bond markets. Yields in country A and yields in country B are much closer than they were. They tend to move in the same direction at the same time.

One of the geopolitical risks is the possibility that that convergence begins to go into reverse. There are a number of reasons for that. The first is that some of the natural buyers of US treasuries, such as the Chinese, might not be natural buyers in the future. The second factor is the desire, particularly post Covid, on behalf of individual countries to build national resilience. That is code for rebuilding barriers and borders of one kind or another. To the extent that you can rebuild barriers and borders, it suggests that inflation rates might vary more from country to country than we have seen in many a year. Thirdly, if it turns out that individual countries are perceived to be making mistakes with regard to macro policy, you can have individual penalties coming through for countries that perhaps were not there previously. I am thinking here of the Truss-Kwarteng response back in September 2022.

The comfortable convergence of bond markets, as you might call it, which was a fundamental feature of the years leading up to the global financial crisis and beyond that, may be at an end.

The Chair: Can I quickly ask what concern keeps you awake more at night? Is it the situation in the US or China with regards to debt? Where would you say your greatest concern would be? It may be neither. Erich, would you have a view on this at Fitch?

Erich Arispe: Both will be equally concerning in terms of representing risks or a headwind to the global economy. I would not be able to rank them.

The Chair: Stephen, just out of interest, would you say one should concern us more, or are they equal?

Stephen D King: They should both be concerning us. It has been going on for a long time. Beijing and Washington’s relationship has been poor since pre Trump, first time around. To the idea that somehow this is a new feature, it is not. It is potentially bubbling away under the surface.

Q187 Lord Burns: I should point out that many years ago Stephen and I worked together in the Treasury. It was more years ago than I care to remember. We discussed some aspects of the debt sustainability equation. Does the structure of the UK’s national debt have any significance for this issue of sustainability and the ability to fund deficits in the short and longer term? Is there anything significant in the difference between the UK and other countries? Does that affect the issue of sustainability at all?

Erich Arispe: From our perspective, one of the mitigating factors for the high level of debt in the UK is its composition. First, we have the absence of foreign currency debt, which represents an important asset to have in periods when exchange rates could be volatile, for instance, as we have seen over the past couple of years. Secondly, the financial markets are deep, which supports the financing flexibility of the sovereign. Thirdly, reserve currency status also helps in the UK. Finally, there is the long average maturity of central government debt, which is about 14 years.

How does that compare to other sovereigns? In terms of average maturity, we have the US, Belgium and Korea, which are about 10 years. The UK is on the high side. That is an asset, because it allows you to mitigate the impact of rising financing costs on the debt stock. One of the aspects leading more immediately to an increased interest burden is the share of linkers. In that sense, the UK has around 24% of its debt in inflation‑linked securities.

I would also mention that, in the UK, 29% or 30% of debt is held by overseas investors. For comparison, in France that is about 50%. While acknowledging the risks that that represents, depending on external capital markets for financing, it has been remarkably stable, averaging 29% since the pandemic and remaining resilient even after the period of turbulence at the end of 2022.

One final point to make, underpinning our negative outlook on the sovereign rating, is the high interest cost for the UK. We estimate that interest to revenue topped 10% last year. We expect that to remain in the high single digits, at close to 9% in 2025. That is compared to a median for similarly rated sovereigns of about 2.5%, so clearly there are higher financing or debt servicing costs for the UK. That creates challenges as well.

Lord Burns: You regard the ratio of debt service costs to our revenue capability as being a significant measure.

Erich Arispe: Yes, it represents another source of pressure on the creditworthiness of the UK.

Stephen D King: I am probably not quite as relaxed as you, Erich. In your comparison between France and the UK, I absolutely hear what you are saying, but I am assuming that a big chunk of the people who own French debt are within the euro and therefore do not have any kind of exchange rate risk, assuming that the euro holds together. In the case of the foreign owners of UK debt there is significant exchange rate risk. Although the number may be lower, the exposure is relatively high from an exchange rate perspective.

The index-linked nature of the UK leaves it significantly more exposed than of other countries, which is unfortunate. The other factor that is important is that, thanks to QE, the average maturity of debt has shortened. Therefore, there is a greater susceptibility in terms of rising short-term interest rates to issues of longer-term debt sustainability. That raises a bunch of questions about whether banks’ reserves at the Bank of England should be fully compensated one way or the other. Nevertheless, I would say that there are some specific peculiarities of the UK that leaves it more vulnerable than others.

Lord Davies of Brixton: You said that index-linked debt leads to the UK being more exposed. I was not very clear what you meant. What is it exposed to?

Stephen D King: If there is a pick-up in inflation, for example, particularly where CPI or RPI inflation is higher than wage inflation, under those circumstances the compensation paid to people with index-linked gilts is relatively high, and higher than for other countries.

The Chair: Are we an outlier here, as things stand, or are we in the pack?

Stephen D King: My impression is that on index-linked debt we are an outlier.

The Chair: What about overall? We are getting difference senses from different people as to the extent to which we are an outlier on debt sustainability.

Stephen D King: One question is whether we have particular vulnerabilities. The answer there is that we do. A separate question is whether they matter in terms of debt sustainability. Some of them may not, in the long term. For example, inflation could be high because of high prices relative to wages, but it could equally be high because of high wages relative to prices. The things might change around, in which case the impact in terms of fiscal sustainability itself would differ. The fact that inflation is high, full stop, does not tell you everything about the vulnerability of the UK economy.

It is also the case that our overall level of debt, although it has gone up a long way, is lower than that of some other countries, particularly in the G7. From that perspective, things are not as bad as they might otherwise be.

You may say I am simply a mouthpiece for the OBR here, but the OBR’s projections for the next 30 or 40 years are worrisome. They are based on similar assumptions to the Congressional Budget Office in the US. Admittedly, the CBO’s projections only go out to the 2050s as opposed to the 2070s. You are not really comparing apples with apples, but, if I recall, for the CBO, government debt rises to about 150% of GDP by 2050 or 2055. In the case of the UK, it gets to over 300% by 2070. That is on a reasonably heroic series of assumptions with regard to defence, the green transition, and so on and so forth, which may prove difficult to control. The UK does not look that great, in my view.

Lord Burns: Can I just press you a bit on the case you make about the debt service cost? If our debt ratio is about the same as a number of the other OECD countries and we are living in a world where interest rates are largely determined in world markets, how can our debt service costs to revenue be so much higher than in those countries?

Erich Arispe: It is related to the debt composition. We discussed the issue of the high proportion of linkers. It is also an issue of the materialisation of losses from the transfers from the Treasury to the BoE for the reverse QE, or QT, as well as the greater monetary tightening in the UK compared to the ECB, for instance. From a rating category perspective, that is why the UK debt service stands out.

Lord Burns: Looking at the geopolitical events you and Stephen have talked about, and the long period when we did not have world shocks, if we now look back and count them, in terms of the oil price shocks, the financial crisis, the pandemic and Ukraine, we are now looking at one event in less than every 10 years over the last 50 years, since this all started in back in 1973. How well positioned are we for another shock over the next 10 years? How does that compare with other countries?

Stephen D King: The answer over time is that we are less and less well prepared for shocks, for the simple reason that, in between the shocks we have had, we have made very little progress in reducing debt during those periods. To emphasise this, if you go back to post World War II and think about the trajectory of debt, it continuously falls decade by decade. It may have accelerated slightly while you were at the Treasury.

Lord Burns: There were no shocks.

Stephen D King: There were shocks. There were the 1973 and 1979 oil shocks.

Lord Burns: There were no shocks up until 1973.

Stephen D King: Up to 1973, there were not. I absolutely accept that the 1950s and 1960s were relatively smooth running. To be fair, the UK in that period had a tremendous constraint, which may have prevented it from doing things it otherwise might have done, namely the balance of payments constraint under Bretton Woods. You could say that we have moved from a constrained world, whereby we had very limited ability to respond to shocks that came through, to a world whereby we have been almost unconstrained over the last 15 to 20 years. The shocks in some cases have possibly been bigger, but we have not had much of a constraint on what we do about it, partly because of QE, partly because of a lack of particularly credible fiscal rules. We have ended up in a position whereby we are less prepared for future shocks than might otherwise have been the case.

In an ideal world, you want government debt during the good times to drift lower. I do not see much evidence of either political party really talking in those terms.

Lord Burns: Do you have a view on this?

Erich Arispe: I will refer to my earlier comments about the sources of pressure on the ratings or creditworthiness of developed economies, including the UK. After these successive shocks, we have had debt increasing significantly and, for the UK specifically, we have lacked visibility or information to assess the fiscal strategy that will try to regenerate the fiscal space in order to address the possibility of continued shocks.

Stephen D King: Could I just add one more thing? This goes back to the days of the MTFS—the medium-term financial strategy. Back in those days, there was a strong sense that monetary and fiscal policy were linked. It was partly the idea that the Budget position fed through into the credit counterparts, which in turn determined sterling M3, which in turn would have an influence on the performance of inflation. The idea was that monetary and fiscal policy had to work together to give you a credible long-term path.

Since the advent of the central bank’s independence and the evolution of QE, that idea of monetary and fiscal policy working together has broken. You have fiscal policy heading off in this direction and monetary policy heading off in that direction. Bringing them back together may be difficult.

Chair: We may come on to that in a moment.

Q188 Lord Rooker: In some ways, you have touched on the question I am going to raise in answers to about three or four separate questions. It is about the OBR’s long-term debt projections based on the steady rise in the dependency ratio. What confidence can we have in the demographic assumptions that underpin the projections? We have asked this question of several people. The inactivity rate we have now was not forecast. We have had 15 years of flatlining life expectancy. That was not forecast. There are other issues as well. What confidence can we have in the assumptions that are being made? From what you have said so far, there is very little, but I would like you to put it on the record.

Stephen D King: If I can go back a few decades and think about why the US had a much better demographic story than other countries in the G7 for a number of years, it was partly associated with the opening up of migration from Latin America and from Asia in the 1960s and beyond. That increased both the size of the population and the average birthrate of the population. The new immigrants tended to have higher birthrates than the existing population. Admittedly, after two or three generations, that all changed, but for a while you would get a burst of people who are typically of working age or going to fuel future working numbers.

The US demographic numbers proved to be much more economically helpful than was true for Germany, France, the UK—a little less so—and Japan in particular, which is very much against immigration altogether. That is one factor.

The second factor I would emphasise is this idea that, even if the demographic numbers are right, it does not tell you everything that you need to know. For example, if it were the case that we had more people getting back into work over the next 20 years or so, so the actual labour force participation was higher than it is today, that would make a material difference in terms of demographic sustainability, even though the demographics themselves would not have changed in any significant way.

A third factor is that economists in general are utterly hopeless at forecasting productivity. The supply side of the economy is the ultimate arbiter of whether you are going to be rich in the future. Our record as economists in that area has been generally quite poor. We might have some vague ideas of what might improve the supply side to a certain degree, but often we discover the supply side improves in ways that surprise us. In the late 1990s in the US, there was very strong economic growth for a sustained period, probably associated with the new economy. It was not forecast by the vast majority of people, yet it did materialise for a while.

It is certainly true that what the OBR is saying into the long term is based on a series of assumptions that themselves can be questioned. You could also say that there is no particular reason to think that the assumptions should be questioned in one direction and not the other, because things could happen that would be entirely negative. For example, going back to Lord Layard’s question about globalisation or the geopolitics, that could work in a very negative direction for the UK. The productivity slowdown we have experienced may become worse rather than better over the next few years. AI may deliver significant gains in profitability for companies that use it, but it may not translate into higher living standards for the many.

To give an example, during the technology bubble of the 1990s and beyond, you can see the effect of that in the US economy, particularly its profitability, but the wage levels for the bottom 80% of the income distribution have hardly shifted. What has been positive for some parts of the economy has not been positive for all of it. Sometimes a technological shift, rather than raising productivity, can simply change the distribution of income within the economy, which may not be helpful for the Government’s long-term finances.

Erich Arispe: I do not have much to add. For medium-term projections, we have our in-house economics team that provides scenarios on the main macroeconomic indicators. We derive public finances forecasts from that. For long-term trends or projections due to ageing of the population and other factors, we rely on estimates from reputable critical sources, such as the OBR, OECD and IMF. We acknowledge the challenges of long-term forecasting depending on the starting point assumptions. The important thing is that they flag a potential headwind or vulnerability to public finances. That has to be taken into account in what policy actions are taken in the medium term to address these long-term challenges.

Lord Rooker: In terms of productivity, the country has been told for several years now that, under the green agenda, a different kind of economy will make us more productive and get more bang for our bucks. We have had lots of evidence in this committee that this does not work, because not everybody who puts up a windmill accounts for the intermittency factor in their costings and the charges, so it is going to be more rather than less expensive.

It is not so much a demographic change, but a productivity issue that at some point we have to get to grips with. We have to assume we are not going to have productivity. The Chancellor next week will give us some estimates that we are going to have a boost in productivity and in production. The assumptions look as though they are going the other way.

Stephen D King: On the green transition, I am not an expert in this area at all. My main thought is that there is a public policy issue, which is to do with the speed at which the transition takes place. The public policy issue is that the green transition requires a lot of investment in fixed infrastructure. It is not capital. It is mobile across borders. It is there. You put it in off your coast, you put wind machines in or whatever it might be. Once it is there, future Governments can tax it very easily.

As a company looking for returns to the shareholder, you might choose not to invest as much as you ideally should for the benefit of the country as a whole, because you are worried that if you invest too much you are a sitting duck for future taxation. The classic example of this in recent times is probably the telecoms companies, which were making an absolute fortune in the 1990s. Their share prices generally around the world have gone down significantly because, having put the infrastructure in, they have not been able to make the profits that they had expected.

What I am getting at here is that there is a fixed cost of the green transition, which may be very high. The benefit later on is effectively the idea that the marginal cost of energy to us once those fixed costs are in place is potentially very low. The microeconomic conundrum is, if the marginal costs are very low, how you make sure that the investors who put in the money in the first place will make sufficient returns to make the fixed costs worth while.

The Chair: Can I quickly ask you a question about immigration? When you look at the OBR forecasts, it is projecting 315,000 net migration ad infinitum. It strikes me that within our forecasts we are highly reliant on very high levels of migration looking ahead. Therefore, were there to be a change in that, those growth forecasts would be quite susceptible and vulnerable to being downgraded. Would you agree with that?

Stephen D King: Probably, yes, at the margin. The reason for saying this is that migrants tend to be of working age. They are not always, but they tend to be. Therefore, if your demographic problem is one of a shrinking working age population relative to your ageing population, migrants can help change that balance. There are a bunch of separate issues about demand on public services and so on, which are free to all, but in terms of the overall balance the evidence that I have seen would suggest that immigration tends to be a net positive for the economy. If you stop it or reduce it significantly, it may be more of a struggle in terms of the overall growth rate.

Going back to this idea of ageing populations, there are only a limited number of ways you can solve for them. One is to wave a magic wand and get a productivity boom, but that is not guaranteed. The second is to bring more people in. The third is to export your capital to where the people already are, so you live off the returns of that investment, which arguably Japan has done over the last 30 years by running a large current account surplus for most of the period. The other way is to raise retirement age or to make sure that people can work freely for far longer into what is standard retirement age, rather than people just walking away from work at 60, 65 or whatever it might be.

Q189 Lord Razzall: The question I am about to ask I have asked of a number of witnesses. They have all given different answers. Let us see if you can agree. It is a question of how best to measure the sustainability of our national debt. The traditional method is to take the metric of debt as a percentage of GDP. The alternative, which a number of people have floated, is to look at a balance sheet approach. Which do you favour?

Stephen D King: I probably favour neither of those. The complication of debt sustainability is the size of your primary surplus, so basically the borrowing or saving that you are doing, excluding debt service costs, relative to the underlying performance of the economy and the level of interest rates, which determines the debt service costs themselves. Effectively, debt sustainability is determined by the underlying growth rate, the inflation rate, the level of interest rates and then the primary surplus or deficit that you might have at any particular time.

It is fair to say that the higher your debt level is at the beginning of that process, for any given shock in terms of interest rates rising, the more quickly your public finances will deteriorate, because the starting point gives you a higher debt service cost, which in turn implies that your primary surplus has to be bigger to offset the size of that debt service cost. Then you bump into the political constraint that what is desirable from a debt sustainability position may not be possible politically. If you think you can get away with having higher levels of debt, you probably will do.

Again, the evidence from the last 15 years is that, because bond market vigilantes have been silent or disappeared to do something else, there has not been much of a punishment. Therefore, people have taken the view that higher levels of debt are perfectly reasonable, but they are not sustainable to the extent that the debt-to-GDP ratio would continuously rise on current and prospective fiscal plans.

Lord Razzall: You do not think that is the best way to measure it.

Stephen D King: No, you have to take into account these primary positions. You also have to make some heroic assumptions, frankly, about the underlying growth rate and the underlying inflation rate into the future. They are heroic assumptions. What I would say is that I did some work 15 years ago, or maybe further back than that. It was a series of government-debt-to-GDP projections for G7 economies based on what we knew just coming out of the global financial crisis. It is fair to say that, even then, it was pretty obvious that government debt would rise quickly on all the likely policies that were going to be pursued.

To the extent that QE insulated Governments and allowed them to get on with it, the underlying costs of doing it were lower than would have been true in any other post-war period. The problem today is that, now that inflation has picked up and the level of interest rates to keep inflation under control is higher than it once was, those metrics look less attractive than they would have five years ago.

Lord Razzall: Erich, what is your view?

Erich Arispe: From a Fitch Ratings perspective, the most comprehensive and probably relevant measure for us is general government debt. That is consolidating central government, local government and social security. In the context of rating agencies, it is probably the measure that lends itself better to international comparisons. We also look for debt sustainability purposes at the cost of servicing this debt, which is interest to revenue, because that informs us about the future path of debt as well as the fiscal space that the sovereign has to respond to shocks or provide support to the economy.

In terms of the question regarding a balance sheet approach, we use net general government debt. That is netting out only the government deposits in financial institutions, because those reflect the liquidity and financing needs for a sovereign in a determined year. The challenge for us in order to move to a balance sheet approach is that, while debt is more easily measurable, when we look at the asset side there are valuation problems and liquidity problems. At an international level, it may be problematic to find comparable measures and methods in order to measure the liquidity and the value of these assets. It can obscure the fiscal picture of the underlying trajectory of the financial liabilities of a sovereign.

Lord Razzall: You cannot value a school.

Erich Arispe: It is very difficult to value a school in England or in Turkey, for instance.

Q190 Lord Griffiths of Fforestfach: I would like to ask a question first to Erich, if I may. As you look around the world and see different countries with different debt rules and so on, do you think debt rules are a good thing or not? We have seen people saying fiscal rules are an anchor and others saying they are irrelevant.

Erich Arispe: A record of compliance with fiscal rules or demonstrating commitment to fiscal prudence provides an anchor. In the context of several successive shocks, as we discussed, it is very difficult to develop such a track record. Of course, fiscal rules represent an anchor and can inform the judgment going forward if they are transparent, realistic and predictable, and have some degree of flexibility, not only to dictate or forecast a certain debt decline or fiscal consolidation path, but to specify in which way Governments will react when the path has to be abandoned because of a shock. That is a broader international context.

In the case of the UK, our view has been that the sovereign has a demonstrated track record of reducing fiscal deficit, which happened in the previous decade. The current fiscal rule probably faces a couple of challenges. One is the repeated changes that have happened in fiscal rules. The most recent change happened less than a year after the previous fiscal rule or fiscal framework was legislated.

Secondly, along with this rolling target, it provides this measure of headroom that may be fulfilled in different Budgets but may fail to reduce debt to a sufficient level to regenerate the fiscal space that has been used through successive shocks.

Finally, this fiscal rule or path to fiscal consolidation is underpinned in expenditure projections, especially starting in 2025, that may prove difficult to implement as they imply real cuts to unprotected expenditure.

Stephen D King: Fiscal rules generally are quite useful, at least as a marker to shape the debate, particularly in the UK between the Treasury and the various spending departments. Without a fiscal rule, it is a free-for-all, even though one can accept that all fiscal rules eventually reach their end because of changing economic circumstances that force you to break a particular rule. For a while, it serves as a useful discipline. What I would note in recent years is that people have not taken fiscal rules particularly seriously, partly because of QE, to the point now where the Prime Minister and the Chief Secretary to the Treasury appear not to know precisely what the fiscal rule is or indeed how to interpret it.

I would suggest that this current fiscal rule is a relatively weak one. Saying that debt is going to fall as a share of GDP in the fifth year means it can go up a long way as a share of GDP in years 1 to 4. I fully accept that there are other aspects of the fiscal rule, such as reducing the borrowing requirement and some limit on welfare spending. As I understand it, the Labour version is basically falling by the fifth year or the final year of the next Parliament, which is not a hugely different rule apart from the fact that presumably it gets closer and closer over time. Because people have not recognised the longer-term problems associated with continuously rising government debt, fiscal rules effectively become less and less important.

That is a bit like saying, “I’ve been driving down the motorway at 100 miles an hour for the last few months and I haven’t had a crash yet, so why worry about it?” The rules are there for a reason. The same thing should be there for fiscal rules too.

Lord Griffiths of Fforestfach: We have taken evidence from a number of people. One thing I have observed is that public servants have a tendency to argue for complex fiscal rules. If you look at the evidence of Switzerland and Germany, they have taken a different approach: “Forget about complexity. Let’s have a simple rule: a debt brake”. Everyone understands what it is about, and they have been very successful. If you look at the ratio of debt to GDP in Switzerland, it is really low; in Germany, it is about 65%. I wonder what you think of that.

Stephen D King: It partly reflects differences in society values. Going back to the 1970s, Germany had a tremendously successful experience when faced with big oil price shocks. The UK did not. If the UK had tried to deliver German-style policies in the 1970s, it would probably have struggled. I could be wrong about that, but that is my sense of what would have happened.

As I understand it, Switzerland’s debt brake is partly conditioned by the fact that its population has voted through referenda to hold the tax take and GDP at a particular fixed point. If you know that taxes cannot change in any significant way, you need to have some fixed control of public spending.

That might be an imposition on UK voters that is further than any political party would like to go. In other words, it ties your hand behind your back on the tax front to such a degree that you cannot possibly afford to go down the generous public spending route, because you will almost inevitably bump into a problem. It is not just the debt brake, as I understand it, in Switzerland’s case. It is also this constraint in terms of the tax burden and GDP, which effectively cannot rise from where it is currently.

Lord Griffiths of Fforestfach: Stephen, you said that fiscal rules do not have teeth in the UK. If you wanted fiscal rules to have teeth, what reforms would you make to the OBR, or to the relationship between the Chancellor or the Treasury and the OBR?

Stephen D King: For me, the obvious reform would be that the OBR would make a judgment about how plausible current policies are, as opposed to taking current policies as given and then working things out for five or six years down the road or whatever it might be.

I accept that there are big democratic questions about this. I accept that in one sense that is basically saying to the Government of the day that the OBR does not trust what they are saying, which does not look good, but there are ways around that. One would be to say, “Let’s have two scenarios”. One scenario is based on what the Government is promising in terms of delivery over the next three or four years. Another scenario says, “In the event that these promises cannot be delivered, what would the consequences be for government debt?” You would be able to say in advance, “If you don’t do this, that and the other, there will be consequences. We’ve spelt out in advance what those consequences would be”. That strikes me as being a nice halfway house that would get you into a slightly more constructive debate than is taking place currently.

Lord Griffiths of Fforestfach: That is a very English compromise.

Lord Turnbull: Is that not effectively what the IMF does? The IMF makes up its own mind on what it thinks about fiscal policy, whereas in the UK the OBR has, for the first five years, to accept what the Government are saying the policy is.

Stephen D King: I believe that is the case, although I would note that the IMF does not have the same domestic media teeth that the OBR has. Although the IMF has that ability, a voice from Washington is not the same as a voice from London.

The Chair: You say the current rule is misleading, Stephen, but do you think it is worse than that? Do you think it is damaging by giving us a false impression of where we are?

Stephen D King: The alternative is to say that that is a matter for Parliament to debate. One party says, “This is what we’re going to do”. The other party can quite reasonably say, “Show us how you’re going to do it. What are you going to do to demonstrate that?” I suspect the reason why that debate does not take place is that neither party wants to admit the extent of the difficulties.

The Chair: This is exactly what I am trying to get at. Debt sustainability is an enormous issue, in my view, which is why we are having this inquiry. The fact that we have a fiscal rule that talks about headroom, and all this new lexicon, allows us to push this issue to one side or at least camouflaged it from public view in some shape or form. Hence the Prime Minister can talk about debt falling and all these other things. Maybe you disagree.

Stephen D King: I do agree. It gives a false sense of sustainability and a false sense of reality, in truth, that is not there. From the OBR’s perspective, the difficulties come later by definition, because it is forced to adopt assumptions that may not be realistic in the short run. That comes back to my compromise, which is that you have two scenarios. You have one, which is what the Government are saying, and the other says, “Let’s drop those assumptions. They may be difficult. They haven’t been spelt out in full force. Assuming that they aren’t going to happen or that the Government haven’t spelt out the details of it, we can put in an alternative scenario”. That would be helpful.

Q191 Lord Blackwell: Can I come on to the question of taxation? Obviously, the extent to which the debt rises depends on the balance between spending and taxes. There may be two issues. One is the overall level of taxation; the other is the structure. I will start with structure. Are there ways that we could realistically structure our tax take in the UK to have a less damage impact on growth or to encourage growth?

Erich Arispe: As a rating agency, we cannot provide policy advice. We will refrain from answering that question.

Lord Blackwell: Stephen, you are on your own.

Stephen D King: You come back to my earlier remarks that you could go after people who are not likely to spend very much and who have lots of wealth, so people who have seen significant gains in house values, stock market portfolios and so on. You would then shift towards more in the way of wealth taxes rather than income taxes or sales taxes. The distorting effects of that might be lower, but there are huge implementation problems. Most obviously, what would the Daily Mail say if turns out that your life savings have built up under your house and they are taxed away 20 years before you are expected to pass away, so to speak? That sort of thing becomes very difficult.

I will add two separate things. First, for a given size of the economy, how can you raise more tax without damaging the economy? It might be these kinds of wealth taxes. The second thing you really want to focus on is the kind of tax reform that might generate more growth. There is a lot of debate about this. I am not a tax expert, so I do not want to push this too far. Things such as stamp duty are arguably a big constraint on growth, because you are throwing sand in the works of the liquidity of the housing market and making it more expensive for people to move. That might slow things down from a geographical mobility perspective. From a public spending perspective, you might put more emphasis on trying to get people more easily to move to where jobs are, rather than where they currently are, which might be spending on various forms of infrastructure alongside getting rid of or lowering stamp duty.

I come back to my earlier comment, which is that, if you are working on raising funds through wealth taxes, for example, other things being equal, the redistribution of income should lead to higher levels of demand. Unless you have higher levels of supply associated with that, you will end up with either a higher interest rate or a weaker balance of payments position than you bargained for. Alongside that, you might end up with a weaker exchange rate than you bargained for. Unless the reforms really add to economic growth in some material way, the redistributional effects at the macro level may bring their own difficulties with them in terms of monetary exchange rate outcomes that you did not originally expect.

Lord Blackwell: The challenge is whether it is realistic to think we can tax our way out of the debt sustainability challenge that we are talking about. The OBR projections show spending, because of demographics, going up to 65% of GDP in 2050. You may doubt some of the demographic numbers, but, given the ageing population and people living longer, there is a bulge of people who are going to get older and be more dependent.

Unless the retirement age goes up dramatically, taking the OBR assumption of essentially a 50% increase in the dependency ratio over the next 50 years, if you work that out, that is about 0.8% a year growth in that ratio. If you look at GDP per head, which is the real measure of living standards, you have to have productivity per worker of more than 1% growth in order to offset the dependency ratio growing 1% a year in order for living standards to rise at all.

Stephen D King: I remember I was in Japan a few years back and talking to an official at the Ministry of Finance. They were talking about the advent of robotics and how this would transform how they would look after older people. In hindsight, it has not been quite so easy as they might have expected at the time. People do not generally want to be looked after by robots. That has been a tricky issue.

The other thing you can think about is a sort of Hayekian view. That is to say that a lot of things that are provided in terms of public goods should instead be priced. In other words, you move away from the free provision of all these things. You say, “There is an economic price for some of these things. We have technologies now that allow us to price these things in a way that we could not previously”. It is hugely politically controversial, but you are shifting away from the burden of taxation to saying that people pay for services that they are consuming.

You can do it for congestion or road journeys. I am not sure I can even say this, but, for GP surgeries and things, people could pay a nominal amount. If you look at the French health service, there is payment up front for services that we do not have in the NHS. There are things you could do that might reduce the tax burden, but what you are doing is effectively shifting the cost of it directly to the consumer, which may or may not have effects on how much they consume of that particular product.

Lord Blackwell: We will come on to productivity in a minute. My point is that, if the productivity per worker is not growing quickly enough to offset the increased number of dependants each worker is supporting, no amount of tax redistribution, either from the workers or by taxing the wealth of the dependants, is going to solve the problem.

Stephen D King: In that scenario, if you are trying to pay for this group of people to have particular levels of services, someone else will have to become a lot poorer in that process. There may be a political limit as to how far you can go in terms of raising taxes for that payment. That is true.

Lord Blackwell: Do you have a view on what level of taxation as a percentage of GDP starts to become sustainable?

Stephen D King: No, not hugely. All I would say is that there has been a lot of discussion about the fact that we are too high. We are higher than the US but lower than Europe. If you look at our growth rate, it is one of the worst. We are in neither position, really. For every argument that says that you cannot go for higher taxes, there is normally a country you can find that has done perfectly well with higher taxes; there is normally a country you can find that has done perfectly well with lower taxes. The relationship is not quite as strong as one would ideally like it to be to give an answer to that question.

Lord Blackwell: The empirical evidence over the last 50 years is that the UK has never managed to raise more than about 38% of GDP in tax, however hard it has tried.

Stephen D King: That comes back to a political story, which is that the British public are simply unwilling to pay more than that. That is where you bump into this longer-term problem. You have this precommitment to paying for these kinds of benefits, but you are constrained by the extent to which the British public are not prepared to pay more in the way of tax. That is partly why you end up with this debt bomb, because the need for taxes is dependent on a rapidly ageing population, but the way you got tax in the past was through rapid economic growth. As I said before, we have not had that over the last 20 years.

Lord Blackwell: Given the issues that are coming from this growth in spending, if we cannot raise the taxes to cover it, do you think a simpler and more honest fiscal approach would be to commit to caps on the level of expenditure relative to GDP of 40% or 50%, and to plan within that?

Stephen D King: You could, but that bumps into the same fiscal rule problem, which is that the cap will last for as long as the public will accept it. It will blow off at some point, because something will happen that means it breaks down. The more I think about this, the more I think that, if you have a lack of debt sustainability, but you also have a lack of political will or ability to act upon it, the most likely way in which you are forced to act is through some kind of financial upheaval, unfortunately.

Lord Blackwell: We may be heading for that.

Q192 Lord Rooker: Briefly, in respect of making the tax system more efficient, we heard from one witness three or four weeks ago that, after 35 years, revaluation of council tax is long overdue. Coupling it with scrapping stamp duty, so that you put the two together, would be a way of modernising the tax system that is beneficial to productivity. Do you have a view on that?

Stephen D King: It is odd that revaluations have not taken place for more than 30 years. If you have a system that is designed to get people with more expensive houses to pay more, if the house value has gone up dramatically, they probably should be paying more.

Q193 The Chair: Can I ask Erich a quick question on Lord Blackwell’s point? To quote your December 2023 outlook, you said, “Recent, faster-than-expected revenue growth has been directed at tax cuts that could lift the UK’s growth potential in the medium term but fail to reduce public finances’ vulnerabilities due to high government debt and borrowing costs”. Just to be clear for the record, what you are therefore saying is that, if this Government or any Government come forward with tax cuts but do not grip the issue that we were just discussing about spending and see debt continuing on its current path, that is a matter of concern for you and for Fitch.

Erich Arispe: Yes, I would agree with that characterisation. It ties to the drivers of why we have a negative outlook. There is uncertainty about the feasibility of a sustained fiscal consolidation. Some of the better-than-expected results are directed towards policy priorities that are linked to trying to address constraints on growth, such as the labour market and investment. At the same time, the actual impact on growth is uncertain in terms of magnitude. In the near term, the fiscal challenge remains in terms of this high debt and rising interest costs.

The Chair: Just in layman’s terms, from Fitch’s perspective, are you thinking that the prioritisation should be on grappling with and putting government debt and borrowing costs before tax cuts? I realise obviously the two are connected, but, if that makes sense, should that be the priority and the main focal point, to get debt under control?

Erich Arispe: From a rating perspective, looking at willingness and capacity to service debt based on our criteria, one of the relative weaknesses of the UK is the public finances profile in terms of the level of debt, as well as the high cost of debt service. Actions or policy choices taken in the near term that fail to address these issues or to increase the certainty that they will be addressed over the medium term are not conducive to stabilising the rating.

Q194 Lord Lamont of Lerwick: Good afternoon. Apologies for the late arrival, having missed the first part. My question was partly touched on already and partly answered, having been put forward by Lord Blackwell. It was on the importance of productivity in the context of long-term debt sustainability. Maybe you could just give us your views on the causes of low productivity and the measurement of it.

Stephen D King: It is a shame you missed the first bit, because I have talked about this already, to a degree.

Lord Lamont of Lerwick: We can skip it then.

Stephen D King: Just briefly, it is worth stressing that the last 20 years have seen very poor productivity performance, not just in the UK, but in the US, relative to its own history and relative to much of Europe. All these places have seen poor productivity gains. One of the oddities about it is that we have seen significant technological changes that you would have thought would have lifted productivity as opposed to holding it back. One possibility is that it has lifted productivity, in the sense that our living standards in a non-market sense have gone up, but that has not really helped government finances, because if it is in a non-market sense there is no income being generated from these things to allow Governments to benefit.

The second possibility is that the technological gains have not led to significant changes in productivity. What they have changed instead is the relative bargaining position of capital versus labour. There is quite a lot of evidence of that in the US, where auction sites for labour and so on effectively mean that you have the exact opposite of unionisation. You have individual workers competing with each other for jobs and bidding for lower and lower wages to get those jobs. You get this pressure coming through from that perspective.

The third factor is that automation has led to a big reduction in job opportunities in what you might describe as middle-ranking areas of work. People with reasonable levels of education discover that they are no longer needed for the jobs they were previously doing. That in turn has led to a significant shakeout of labour. Those people have competed with people in lower-paid jobs and have pushed pay even lower.

My point is that we often think of technology as driving productivity, but it does not have to. It can change the distribution of income as well. That is something that has happened over the last 20 or 30 years. Looking at the US as the extreme example, the profit share in GDP have gone up dramatically over the last 20 or 30 years. By definition, the labour share has gone down dramatically over that period. The economy has not grown particularly quickly or particularly slowly. If you asked, “Where’s the evidence of technology?” I would say it is in that distribution of income rather than in the idea that productivity growth itself has been boosted.

This is unfortunate. People’s answer to the question, “What is going to drive decent productivity growth?”, is normally technology. In this case, it has not worked in quite the way that people had expected.

Lord Lamont of Lerwick: When it comes to the causes of low productivity, there seem to be a lot of different explanations. Some people blame quantitative easing. Some people blame low interest rates. Some people blame lack of investment. NIESR has put its money on lack of investment. It has suggested that there should be an investment target of 3% of GDP. Its opinion is that that would raise productivity growth, but that this is inconsistent with the short-term arguments put forward for the GDP-to-debt ratio, where five years is not long enough to realise the gains that would come from the 3% target.

Stephen D King: First, I should say that I am on the council of management of the National Institute of Economic and Social Research, so I want to declare an interest.

Lord Lamont of Lerwick: I am a governor of it as well.

Stephen D King: This is just in case you thought I might have a biased view one way or the other.

QE has not necessarily helped. QE was designed to raise the incentive to invest in riskier asset markets. That basically means people coming out of gilts and putting money into the housing market or the equity market. There is some evidence to suggest that it has created a world in which badly run companies survive for longer than they should. The number of bankruptcies over the last few years, particularly since the global financial crisis, has been unusually low relative to what you might expect. In one sense, that is great because people have kept their jobs, which is lovely. In terms of the allocation of capital, if QE has contributed to keeping companies going that should not be kept going, it is effectively a subsidy to low productivity performance. That could be a factor.

The second factor is that, if interest rates are very low, the hurdle rate for investment itself is very low. It is not so much that you do more investment, but you might just do the wrong investment. The extreme example of this is Brazil in the 1960s and 1970s, where the hurdle rate for investment was ridiculously low. There was a lot of investment, but there was no productivity. That is another danger.

Thirdly, with regard to having higher levels of debt, Andy Haldane made an argument in the FT a while ago that the great thing about higher levels of debt historically is that they have been important in driving the investments we have made in education, social welfare, the NHS and so on and so forth. I have to say, I did not really agree with that argument. The reason for that is that the big increases in government debt in the past are mostly associated with warships, aeroplanes or weapons, because they are all happening in wartime.

During peacetime, there has typically been enough economic growth to allow public sector projects to be sustained and, at the same time, for government debt to fall as a share of GDP. You are in a beautiful situation whereby the denominator of your debt-to-GDP ratio is rising rapidly, and it allows you to meet a lot of objectives in the private sector and the public sector simultaneously. The problem over the last 20 years is that we have not had the same rate of growth, so there is a much bigger debate about how the spoils are distributed, rather than making the spoils themselves bigger over time.

Lord Lamont of Lerwick: Most of your alleged causes for low productivity in both your answers were ones that could apply to several countries. They do not apply specifically to Britain. The puzzle is why British productivity has been lower than other countries. I know that in many countries this has flatlined, but flatlined at a higher level than in Britain. In your opinion, what is the specifically British cause of British low productivity?

Stephen D King: If we are talking about the recent period, I hate to say this, and I am probably getting into terrible trouble with half of you, but Brexit may have played a role.

Lord Lamont of Lerwick: That would be very recent, though.

Stephen D King: In the last six years, productivity growth has not been great. Prior to that, what sort of time period are you thinking about? Is it just the last 10 or 20 years or the last 50 years?

Lord Lamont of Lerwick: It is the last 10 or 20 years.

Stephen D King: Part of it is associated with the fact that we are a very financialised economy. We were very dependent on the growth of the financial sector until the global financial crisis. The global financial crisis hit countries harder that had large banking systems relative to the size of their domestic tax revenues. The US had a large banking system but also a very large domestic tax base to bail things out. We were in the position of having a very large financial system with a smaller tax base. A lot of resources were devoted to saving the country, which were diverted away from what might otherwise have been productive elements.

Lord Davies of Brixton: Did you say we have an overfinancialised economy?

Stephen D King: It is just more. I am not making a judgment. I work for a bank.

Q195 Lord Londesborough: Stephen, there was an expression you used in a letter to the FT, saying that we had high debt as a result of sustained economic disappointment, which struck a particular chord.

I would like to finish on the subject of net zero, this huge unpriced, unbudgeted commitment. The Climate Change Committee has suggested a gross cost in the region of £1.4 trillion. That would come down to a net cost of £300 billion or so, but with huge sweeping assumptions on net savings and enhanced revenues. There is also a very big question on how much the private sector will get involved. To date, it has not shown huge appetite, for one or two of the reasons you alluded to earlier. The OBR has suggested that, in order to finance this, the Government may have to raise further borrowing in the region of 20% of GDP. What risks do you feel that the green transition poses to our debt sustainability?

Erich Arispe: This is a risk not only for the UK. From a rating perspective, in order to assess the potential impact of this transition, we look at certain factors, which are the quality of human capital, the level of wealth in the economy, institutional strengths, access to financing or the depth of capital markets, as well as the strength of public finances. These factors overall are correlated with a high level of ratings. We can say that higher‑rated economies are better placed to absorb or to manage the transition costs.

In the case of the UK, as we have discussed throughout this session, debt is already high. For us, it goes back to uncertainty. It is another uncertainty subfactor, I would say. In the context of high debt levels, we can see a Government accommodating some structural expenditure pressures relating to ageing costs and to health costs, potential additional defence spending and, going forward, a higher interest cost than we had pre-Covid, for instance. It is just about how the Government go about generating the fiscal space to address these net-zero commitments.

As you said correctly, there are potential benefits or revenues emanating from the transition, such as productivity gains and higher growth, which in turn go into higher government revenues, but the timing and magnitude are hard to discern. From our perspective in looking at the long-term or medium-term trajectory of the public finances, given the high level of debt, it is another question we have on how the fiscal strategy will accommodate these costs over the medium term without taking into account some of the benefits that are highly uncertain.

Stephen D King: We have a historical answer to this, which is partly associated with Keynes’s How to Pay for the War. It is the idea that, if you have to make this green transition, you have to find the resources from somewhere to allow you to make these investments that you otherwise would not be making. You can do that in one of two ways. First, you make sure that interest rates are significantly higher than they otherwise would have been for other forms of investment, so you deliberately crowd out other versions of investment, or, secondly, you find ways of limiting consumption.

During the war, it was rationing. Keynes’ idea was not rationing. It was the idea of having a savings vehicle that would delay consumption until the end of the war. In either way, it was possible to have a very big increase in government debt, which is effectively internally funded from the population as a whole, because its own ability to spend money was significantly reduced. This is a political problem more than anything else, which is to say, “How urgent is the green transition? How much should people believe in the urgency of it? How do you persuade them that it’s urgent? Then how do you put the country on the equivalent of a war footing?”

The key problem with war footings in peacetime is that you are talking about significant restrictions on civil liberties or restrictions in terms of economic opportunity that is denied for a period. I do not have an easy answer to this, but the idea that you simply add to debt and there are no consequences is not true. There will be consequences of adding to debt. You had Olivier Blanchard talking to you the other week, but he has written extensively on this issue. It is focusing on this idea that there are costs. We should be more cognisant of what those are and make the public clear as to they are, hoping that the public will not reject it completely. If they do, we are all frazzled in a few decades’ time.

Lord Londesborough: Those costs, as you mentioned earlier, are partly dependent on the speed we go. If we have been perhaps plucking the low-hanging fruit, the harder yards are ahead, to mix my metaphors. As the OBR suggested, the costs could double if we continue to go at a slow pace.

Stephen D King: Yes. There are other market failure issues, most obviously that, even if the UK goes quickly in one particular direction, it is not obvious that you solve the global climate change problem. If you make a real effort in one country and other countries do not make the effort, you end up at a significant competitive disadvantage. However, the way you would try to sell that is to come back to the idea that the marginal cost of energy at some point in the future will be much lower than it has been in the past. That would be a powerful longer-term argument. The more quickly you do it, the more quickly those benefits come through. The longer it takes, the more difficult it is. Where the weakness with the wartime comparison breaks down is that wars tend to be relatively short compared with 20, 30 or 40 years of climate change.

The Chair: Thank you both very much indeed. We have gone slightly over time, for which you have my apologies. That was a fantastic session with very rich answers. We are all incredibly grateful to you both for coming. Thank you very much indeed.