To estimate the effect of fiscal policy decisions on GDP growth we use ‘multipliers’ drawn from the empirical literature. These capture the indirect effects of the fiscal measures on activity over and above their immediate effect on demand, through raising private incomes and spending. They also take account of the upward pressure this puts on wages and prices and the monetary policy response by the Bank of England necessary to keep inflation at target.a
In Box 2.1 of our November 2020 Economic and fiscal outlook (EFO), we considered whether the unusual nature and size of the current economic shock and the Government’s response meant different multipliers should be applied. Several factors could be raising multipliers (such as the proximity of interest rates to their lower bound) but other factors could be lowering them (such as restrictions limiting individuals’ ability to spend any extra cash). So, as in that report, we have left our multipliers broadly unchanged. But the uncertainty surrounding them is considerable.
In the Budget, the Government announced plans to loosen fiscal policy by almost £60 billion in 2021-22. This includes an extension of the Coronavirus Job Retention Scheme (CJRS), two further Self-Employed Income Support Scheme (SEISS) payments, and extensions to various temporary tax cuts. The Government also announced a large temporary increase in capital allowances. As a temporary measure, it should not affect the long-run cost of capital or level of the capital stock in the long run (see paragraph 2.55), but it should have a temporary effect and, moreover, provides companies with a very strong incentive to bring forward investment from future periods to take advantage of the temporarily much more generous allowances. As a result of the measures announced since November, we estimate that GDP will be around ¾ per cent higher at the peak of their impact in the spring and summer of 2021.
From 2023-24, the Government plans to tighten fiscal policy by increasing the corporation tax rate, freezing the income tax personal allowance and higher-rate threshold, and lowering day-to-day departmental spending limits. The increase in the corporation tax rate will increase the cost of capital, lowering the desired capital stock and business investment in the medium term. On top of this, the boost to business investment from the temporary capital allowance measure goes into reverse, though some of that happens beyond the forecast horizon. But because we assume that the Bank of England adjusts monetary policy to keep inflation on track to meet the target, the fiscal tightening provides only a modest drag on GDP in the medium term.
The combined effect of the higher path of output from the near-term fiscal stimulus and the extension of the CJRS means that, without the latest measures, unemployment would have peaked two quarters earlier and at a higher level. Specifically, we estimate that unemployment would have been about 300,000 higher in the fourth quarter of 2021 in their absence.
Several other measures also have effects on our economy forecast:
- A handful of measures directly affect inflation, including the one-year fuel and alcohol duty freezes and the extension of the reduced rate of VAT for hospitality to March 2022. In total, these lower inflation by 0.2 percentage points in 2021-22.
- The stamp duty holiday extension’s main effect on our housing market forecast is to shift transactions to just before the scheme’s new end date, though it does result in some additional transactions and raises house prices a little. The six-month extension is assumed to lower residential transactions by around 30,000 in 2020-21 and increase transactions by about 43,000 in 2021-22. The new mortgage guarantee scheme has not been sufficiently specified to be incorporated in our forecast, but there is some evidence that a similar scheme introduced in 2013 modestly raised transactions.
Temporary support measures, like the CJRS, have also helped people and businesses adapt to operating in a more socially-distanced environment. Without their extension, a tighter path of restrictions and greater voluntary distancing would have lowered activity in April 2021 even further below our November 2020 forecast than the mechanical application of fiscal multipliers would imply. As Box 2.1 sets out, the risks surrounding the epidemiological assumptions on which our forecast is conditioned remain significant. Were the pandemic to unfold less favourably than in our central forecast, necessitating fresh public health restrictions, then the Government may again choose to provide further support to prevent sharp falls in output.