On the 29th March, David Ruffley MP questioned George Osborne, the Chancellor of the Exchequer, on the 2011 Budget.

The text of Mr Ruffley's interview can be found below, and the full text of the proceedings can be found here
Mr Ruffley: Chancellor, the chief economist of the Bank of England said last week, "The risks from continuing global price pressures and the effects of the prolonged period of above-target inflation meant that the level of demand consistent with achieving the inflation target had probably fallen". He was talking about a supply shock. Do you think he is right?

George Osborne: I do broadly agree with the analysis expressed by the bank, not just its chief economist but its Governor as well in his recent speech, about the causes and impact of inflation in the UK and one high degree of caution in the OBR's forecast has been the rather low levels of consumption growth through the period compared historically to the past.

Mr Ruffley: There seems to be an opposition amongst commentators. They would argue the OBR is talking about a demand shock which will allow you to have faster growth after 2015 whereas Spencer Dale is saying something different, isn't he?

George Osborne: You would have to get Mr Dale here to answer the questions about what he said. The way I see it is that the UK faces two particular economic challenges at the moment. One is the higher than expected inflation which as the OBR confirm is largely driven by rises in commodity prices. The second is the European sovereign debt crisis. These are two particular headwinds that we have to deal with as an economy at the moment. Clearly, as is clear throughout this document, the higher than expected inflation has had an impact on many of the forecasts that they made in November.

Mr Ruffley: What do see as the major risks in the economy for the next three years?

George Osborne: I would say those are the two that immediately stand out. The rise in commodity prices has clearly had an impact and of course in the UK exacerbated by the very sharp devaluation which is part of the rebalancing of the British economy but nevertheless has increased the inflationary pressure. Then you have the European sovereign debt problems, which Portugal is the current live example. We have to negotiate our way between those twin threats.

I think there is a broader challenge for everyone involved in economic policy making which is how do we rebalance the British economy in a more convincing way than has been achieved in the past so that it is less dependent on essentially debt-fuelled consumption and is more like an economy that invests more and exports more. That is an explicit objective now of the British Government. The days when the Treasury could be entirely neutral, which was true under both the previous Labour Government and the previous Conservative Government, about the structure of the economy probably are gone and we became unbalanced, overly dependent on one industry-financial services-and overly dependent on one factor of growth-consumption. We need to have more investment, more exports. We need to have a more balanced economy. We need other sectors to do better and other regions to also do better. Achieving that is not going to be easy and I am certainly not under any illusions that the Chancellor of the Exchequer or, dare I say it, even the Permanent Secretary, can sit in their offices and pull levers and everything happens exactly according to plan. The world is not like that and I don't believe in that sense in centrally planned economies. But I do think that Government can do more to encourage this rebalancing than it has does in recent years.

Mr Ruffley: Would you say an overestimation of the output gap is the biggest risk to you not meeting your fiscal rules?

George Osborne: I would say that is what the OBR have identified as perhaps the central risk to their own forecast, but they are independent.

Mr Ruffley: Do you agree with them?

George Osborne: I am very careful to have a regard to their independence and I am not going to try and second guess their estimate of the output gap but they very clearly early on in this document identify their estimate of the output gap as being one of the central risks to their own forecast.

By the way, if I can just remark that the fact that is now an established part of British policy making, in the space of just 10 months, I think it is a very good thing.

Mr Ruffley: I think you are to be congratulated on creation of the OBR for the reason you have just given, Chancellor.

Would you li ke to put a probability on the output gap being much more significant-

George Osborne: No. Not really. No, I wouldn't no.

I guess future Chancellors will have to approach this in their own particular ways. Obviously I am the first Chancellor operating now with an independent forecasting body and as the body establishes itself, I have taken, basically, a vow of silence on what my view is of the different forecasts and the components of that the forecast that they have made. This thing has only been on a statutory footing for a week. If I start saying that I think they have got the output gap wrong or whatever, then I think that would be an unhealthy clash that would potentially damage the independence of the body.

Mr Ruffley: Final question, Chair. Why is there so much policy emphasis being placed on the output gap? Everything seems to rest on it. It is an unobservable economic variable, isn't it? Huge policy emphasis is placed on it when it comes to meeting your fiscal rules. Does that worry you at all?

George Osborne Again the Governor of the bank is also at times quite sceptical about this.

Speaking from my own point of view, the reason is this. We are trying to construct a fiscal mandate, a debt target, and so on, that will bring the public finances to health. When it comes to the fiscal mandate, I think it is important to recognise that there is an economic cycle and that there is a structural element to your deficit and that there is a cyclical element. You need the output gap to enable you to calculate the structural deficit. There is often a sort of black and white debate about John Maynard Keynes at the moment, but one of Keynes' important insights was of the role of automatic stabilisers and that is where we are in a very different place from the 1930s as a country and as a Government. I want the automatic stabilisers to operate while at the same time having a fiscal deficit which does not undermine our credibility in bond markets. So that is why the fiscal mandate is a cyclical one and if you want a cyclical one, then you need to have an idea of what the output gap is.

Mr Ruffley: Thank you, Chancellor.