Scotland: A New Fiscal Settlement

Executive Summary Many commentators have criticised the strategy currently used to finance the Scottish Parliament – both the block grant system, and the small degree of fiscal autonomy devised in the Calman report and the UK government’s 2009 White Paper. Nevertheless, fiscal autonomy has now been conceded in principle. This paper sets out to identify formally what level of autonomy would be best for the Scottish economy and the institutional changes needed to support that arrangement. Our conclusions are in line with the Steel Commission: that significantly more fiscal powers need to be transferred to Scotland. But what we can then do, which the Steel Commission could not, is to give a detailed blueprint for how this proposal might be implemented in practice. We face two problems. The existing block grant system can and has been criticised from such a wide variety of points of view that it effectively has no credibility left. On the other hand, the Calman proposals (and the UK government proposals that followed) are unworkable because, to function, they require information that the policy makers cannot possibly have; and because, without borrowing for current activities, they contain no mechanism to reconcile contractual spending (most of the budget) with variable revenue flows – which is to invite an eventual breakdown. But in its attempt to fix these problems, the UK White Paper introduces three further difficulties: new grounds for quarrels between the UK and Scottish governments, a long term deflation bias, and a loss of devolution.

Time Horizons And Smoothing In The Bank Of England’s Reaction Function: The Contrast Between The Standard GMM And Ex Ante Forecast Approaches

The monetary policy reaction function of the Bank of England is estimated by the standard GMM approach and the ex-ante forecast method developed by Goodhart (2005), with particular attention to the horizons for inflation and output at which each approach gives the best fit. The horizons for the ex-ante approach are much closer to what is implied by the Bank’s view of the transmission mechanism, while the GMM approach produces an implausibly slow adjustment of the interest rate, and suffers from a weak instruments problem. These findings suggest a strong preference for the ex-ante approach.

Time Horizons And Smoothing In The Bank Of England’s Reaction Function: The Contrast Between The Standard GMM And Ex Ante Forecast Approaches

The monetary policy reaction function of the Bank of England is estimated by the standard GMM approach and the ex-ante forecast method developed by Goodhart (2005), with particular attention to the horizons for inflation and output at which each approach gives the best fit. The horizons for the ex-ante approach are much closer to what is implied by the Bank’s view of the transmission mechanism, while the GMM approach produces an implausibly slow adjustment of the interest rate, and suffers from a weak instruments problem. These findings suggest a strong preference for the ex-ante approach.