The economy needs a large and immediate fiscal boost. The latest collapse in bond yields reinforces the attraction of using the maximum possible fiscal levers to stimulate the economy. This fiscal stimulus can be used both to mitigate the negative near-term impact of the virus and to initiate longer-term infrastructure spending. This is the first Budget since October 2018. In recent weeks the messaging around this Budget has continued to evolve and a number of features seem likely:
- addressing the coronavirus will now likely form the main focus of this Budget. There are a plethora of fiscal measures that could be unveiled to help ease cash flow burdens on firms or to ensure help is available to those who might need it.
- this Budget will provide a significant and necessary fiscal boost to the economy. Whereas previously a large fiscal boost was seen by the market as likely to remove any prospect of further monetary easing, the coronavirus now means that there will likely be both fiscal and monetary easing.
- another key message is that the need to address the coronavirus will lessen – but not remove fully – the scope to immediately level up the economy via infrastructure and regional spending. Thus, the Budget needs to be seen in terms of a trilogy of fiscal events, with this Budget followed by a comprehensive spending review later this year and an autumn statement that may yet evolve into a second budget later this year.
What then, should one focus on this week? Three things stand out:
- the macro-economic numbers and what is expected to happen to the economy;
- the fiscal numbers;
- the specific measures that will be unveiled, and how this plays out between boosting the economy now to overcome the virus and longer-term infrastructure spending.
First, the macro-economic context. The initial phase of a Budget is usually focused on the overall state of the economy, including the official forecasts for the main macro-economic indicators such as growth. It goes without saying that there is greater uncertainty than usual, given the virus and its global impact, as well as assumptions about the UK exit from the EU.
The Chancellor will likely remind us that the UK economy has grown at a steady pace versus other G7 countries.
The latest Treasury summary of independent forecasts, in late February, showed that growth this year was expected to be 1.1% and 1.4% next year, largely reflecting a cautious consensus view about the impact of leaving the EU and not yet reflecting views about the virus. The consensus, as is the norm nowadays, sees inflation close to its 2% target, at 1.7% in Q4 of this year and 1.9% next year.
The Office for Budget Responsibility (OBR), who provide the economic forecasts, may suggest growth just above 1%, and slightly higher next year. They will likely assume a temporary hit to the economy from the virus and an orderly exit from the EU. To that will be added the boost from expected continued low interest rates and a fiscal stimulus.
Second, the fiscal context, as this will determine how much room for manoeuvre the Chancellor has. The late February consensus forecasts for the budget deficit, as measured by Public Sector Net Borrowing (PSNB), was £53.6 billion in 2020-21 and £54.4 billion in 2021-22. The margin of error on the budget deficit forecasts tends to be high.
In December the OBR expected this fiscal year’s budget to be £47.6 billion. This looks set to be undershot. Over the first ten months of this fiscal year, April 2019 to January 2020, public sector borrowing was £44.8 billion. This was £5.8 billion worse than the deficit at the same stage of the previous fiscal year. Tax revenues were higher, but so too was spending.
Despite this recent trend, borrowing has been falling since peaking in the fiscal year 2009-10. While the deficit has been declining, the national debt continues to edge higher. At the end of January, public sector net debt was £1,798.7 billion, or 79.6% of GDP. Compared to a year earlier, the amount was higher but the ratio of debt to GDP was down by 0.7%.
There are constraints on the Chancellor. If trend growth is seen as being low then this implies more of the budget deficit will be structural, not cyclical. It is not uncommon to hear the view that trend growth is low, the structural deficit is high and thus there is limited room for fiscal manoeuvre and therefore any spending increases have to be matched by tax hikes.
As a guide, there are fiscal rules, but these have little credibility, with their track record showing they are worked around, ignored and often discarded. Whether one keeps the rules or not, it is necessary to have credible – or sensible – fiscal plans and there are often hard choices to be made on the fiscal numbers. The Chancellor has scope to boost spending in this Budget, while sticking with credible fiscal numbers, dependent upon his projections for growth.
Third, will be the specific measures outlined. A temporary boost to help the economy in the near-term seems inevitable. There will also be the measures outlined to cope with the coronavirus. Often the challenge with fiscal measures is that they take time to feed through. One exception is tweaks to VAT rates, which can be immediate. Immediately after the Global Financial Crisis, for instance, the rate of VAT was cut from 17.5% to 15%.
In recent weeks there has been speculation on whether there would be spending increases or tax cuts. While the government seems keen to lower the tax take, the focus near-term, whether in this Budget or later in the year, is to boost infrastructure spending.
It is interesting how the narrative has changed, not just in the UK but globally. The OECD, as an example, produced much analysis through the last decade of the most effective ways to achieve fiscal consolidation. Now, their focus has switched on how to use fiscal policy to escape low growth, with a particular emphasis on how much “fiscal space” there is.
This is the gap between levels of actual debt and the likely level at which market access would be compromised. That, in essence, is the key here. Measures may be needed, but they need to be credible, with the fiscal numbers on an improving longer-term trend.
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