The economic effects of policy measures

This box considers the possible effects on the economy of the policy measures announced in this Budget and since our previous forecast in March. Further detail about each Budget measure is set out in the Treasury’s documents. Our assessment of their fiscal implications can be found in Chapter 4 and Annex A.

The Government has chosen to loosen fiscal policy materially, largely through an increase in departmental spending. To estimate the effect of fiscal policy decisions on GDP growth we use ‘multipliers’ drawn from the empirical literature. The ones we use imply that a discretionary loosening of 1 per cent of GDP would increase output by between 0.3 per cent (for income tax and NICs reductions) and 1 per cent (for increases to capital spending) in the first instance.a We typically assume that these multipliers fall to zero over five years as the economy adjusts to the policy changes through a number of processes – including the endogenous response of wages and prices to the degree of spare capacity, as well as changes in monetary policy. As explained in the Foreword, we applied our multipliers to a set of policy measures that was then amended beyond the agreed timetable for closing the economy forecast. Our economy and fiscal forecasts are therefore not fully consistent, although we believe the effect of this inconsistency on annual GDP growth would have been less than 0.1 percentage points in any year.

The bulk of the discretionary fiscal loosening in this Budget reflects the increase in health spending announced in June, but it may not have been fully anticipated by market participants – perhaps because they would have expected the Government to announce additional policy measures to help pay for the extra health spending. This would imply that the market interest rate expectations upon which our forecast is based are lower than would be consistent with the looser path for fiscal policy. Consistent with this, we expect the near-term effect of the discretionary loosening of fiscal policy on output to only partly unwind over the forecast period. We estimate that the discretionary fiscal loosening boosts real GDP growth by around 0.3 percentage points in 2019, with growth slightly weaker thereafter as the effect of the loosening diminishes. But the effect does not fully unwind, and we expect a small positive output gap to remain by the end of the forecast period. This is expected to have a modest upward effect on inflationary pressure, leaving CPI inflation marginally above target in the medium term.

We have made a number of other adjustments to our economic forecast for measures announced in this Budget. The Government has announced measures that are expected to affect the cost of capital faced by firms, and therefore the level of business investment. These include: the introduction of a permanent structures and buildings allowance of 2 per cent of the value of qualifying expenditure on non-residential structures and buildings, effective from announcement; a permanent reduction in the writing down allowance for the special rate pool of assets from 8 per cent to 6 per cent from April 2019; and a temporary increase in the annual investment allowance (AIA) from £200,000 to £1,000,000 for two years from January 2019. Taken together these measures are expected to increase the level of business investment by 0.4 per cent by the end of the forecast period, largely as a result of the structures and buildings allowance.

We have adjusted our inflation forecast for a freeze to fuel duty and some alcohol duties in 2019-20, and a freeze in the maximum tuition fee charged in England for UK and EU students. Together, these reduce CPI inflation by just over 0.1 percentage points in 2019-20.

The Government has announced a number of measures that are likely to affect the housing market. These include a two-year extension to the Help to Buy equity loan scheme, but restricted only to first-time buyers and with regional property price caps. We expect this to increase house prices by 0.1 per cent in 2021-22 and to reduce house price inflation slightly in 2023-24 following the currently planned end of the scheme in 2022-23. Residential property transactions are expected to be around 0.2 per cent higher and residential investment just under 1 per cent higher in 2021-22 and 2022-23 as a result of the extension to the scheme.

The Government’s announcement that it will lift the Housing Revenue Account borrowing cap with immediate effect is expected to lead to higher housebuilding by local authorities, although we have assumed that this partly crowds out some private sector housebuilding. We expect the removal of the cap to increase aggregate housebuilding by an additional 9,000 over the forecast period, as an increase in public sector housebuilding of just over 20,000 is partly offset by lower private sector housebuilding (including by housing associations).