Repairing the public finances: the pandemic versus the financial crisis

While borrowing reached a peacetime high of 15.2 per cent of GDP last year, the vast bulk of this was to fund the Government’s temporary coronavirus rescue package, which largely expires
this year. The structural damage to the fiscal position over the medium term is therefore relatively modest (borrowing falls to just 3.3 per cent of GDP next year) – indeed the unprecedented fiscal support provided over the past two years played an important role in keeping it so. Nonetheless, the pandemic has left a gap relative to what the Chancellor considers a sustainable position: current balance and falling debt as a share of GDP. This box compares the scale of the fiscal challenge facing the Chancellor and his approach to repairing the public finances, with the challenge that faced Chancellor George Osborne after the financial crisis.

Over the course of the past 19 months, this Chancellor has announced policies that deliver 1.8 per cent of GDP of fiscal tightening by 2026-27 relative to the pre-pandemic fiscal plans set out
in his March 2020 Budget. Chart A shows that this reduction in borrowing is more than explained by net tax rises (on top of those contained in the March 2020 Budget), which reduce borrowing by 1.9 per cent of GDP in 2026-27. These outweigh the 0.1 per cent of GDP cost of raising public spending (on top of the significant rise announced in March 2020).

The size and composition of this planned consolidation contrasts with what followed the financial crisis – both in terms of the plan set out by Chancellor Osborne in the Coalition Government’s
first Budget in June 2010, and relative to what was ultimately delivered. In June 2010, the Coalition announced a plan to deliver 6.3 per cent of GDP of fiscal tightening by 2014-15. This
represented an additional 2 per cent of GDP of tightening on top of the plan they inherited from the outgoing Labour Government. 74 per cent of the overall consolidation measures were to be delivered by spending cuts, and the remainder by tax rises (mainly by raising VAT). While the Government managed to deliver close to 6 percentage points of fiscal tightening by 2014-15, the persistent underperformance of productivity and real GDP over that period meant the deficit remained higher than initially expected. In response, the Coalition extended the consolidation
period, adding further years of spending reductions to successive plans. By 2018-19, 8.8 per cent of GDP in fiscal consolidation had been delivered, with a slightly higher share of 82 per cent delivered by reduced spending than was originally planned.^a

Chart A: Discretionary fiscal tightening: the pandemic versus the financial crisis

The much greater planned and actual fiscal tightening after the financial crisis relative to this Chancellor’s post-pandemic plans should be viewed in the context of the greater damage to the prospects for potential output (and associated structural fiscal damage) in the former. Our latest central forecast presents this Chancellor with a 2 per cent hit to medium-term real GDP, revised down from 3 per cent in our previous forecast. By contrast, in his first Budget in June 2010, Chancellor Osborne faced an OBR estimate of the medium-term shortfall in output (relative to a continuation of the pre-crisis trend) of no less than 8¾ per cent. And that was itself larger than the 6½ per cent estimate on which the outgoing Labour Government’s plans had been based.^b Moreover, the shortfall in output continued to grow as it became evident that the underlying rate of productivity growth had slowed, with the latest data pointing to a shortfall of around 15 per cent relative to the pre-crisis trend (with many factors likely to have contributed to this beyond those directly attributable to the financial crisis).

A more modest degree of economic scarring from a pandemic than from a financial crisis seems reasonable – the economy did not enter the pandemic with financial imbalances that needed to be unwound. And many forecasters – ourselves included – have revised down estimates of post-pandemic scarring recently. The post-financial crisis experience nevertheless reminds us that the actual extent of scarring that results from acute shocks like these only reveal themselves over time. Should post-pandemic scarring eventually turn out to be greater than assumed, then the size, pace, and composition of fiscal consolidation can be expected to be adjusted accordingly.