In each Economic and fiscal outlook we publish a box that summarises the effects of the Government’s new policy measures on our economy forecast. These include the overall effect of the package of measures and any specific effects of individual measures that we deem to be sufficiently material to have wider indirect effects on the economy. In our March 2022 Economic and fiscal outlook, we adjusted our economy forecast to take into account plans to loosen fiscal policy from 2022-23, to support households with the cost of living crisis, as well as for several specific measures, such as the cut in fuel duty and the freezing of the BBC liscence fee.
To estimate the effect of discretionary fiscal policy changes on economic activity, we use multipliers drawn from the empirical literature. These capture the wider effects of fiscal policy measures over and above their immediate effect on demand, through changing private incomes and spending. These effects diminish steadily to zero by the forecast horizon, as the Bank of England is assumed to respond to the upward pressure on wages and prices with a tighter monetary policy response to bring inflation to its 2 per cent target, by bringing demand back to the economy’s supply potential.
Since our October forecast, the Government has announced measures with an uneven effect across the next five years. These include: a large near-term giveaway comprising £8.9 billion of support to households via council tax and energy rebates, around half of which will be clawed back over the subsequent five years; a temporary 5p cut in fuel duty costing £2.4 billion in 2022-23; and £6.3 billion in personal tax cuts via permanently raising the NICs primary threshold to align with the income tax personal allowance. From 2024-25 onwards, the net tax cut rises to around £10 billion a year as the basic rate of income tax is cut from 20 to 19 per cent. Several other measures have relatively large fiscal effects but are assumed not to affect the path of real GDP. These include the package of reforms to student loans (the long-term effects of which are captured in the accrued fiscal deficit upfront) and the Bulb Energy bailout.
The overall impact of these measures increases the level of GDP in 2022-23 by 0.3 per cent and by smaller amounts thereafter, so growth rates are raised in 2022-23 but then lowered in 2023-24 as the near-term boost fades. This reduces the extent to which high energy prices are expected to drag output below potential in the near term. In fact, the income tax cut in 2024 results in a very modest degree of excess demand as it takes effect when falling energy prices are also expected to boost household disposable incomes and consumption.
The combined impact of the energy-related support measures and tax cuts in 2022-23 boosts household disposable incomes by £17.6 billion. This reflects £350 worth of rebates for most households (£150 in April and £200 in October), the £6.3 billion NICs cut, and the 0.1 percentage point reduction in CPI inflation as a result of the temporary fuel duty cut. But as discussed in Box 2.5, real household disposable incomes still fall by around 2 per cent in 2022-23 – with the rebates and tax cuts reducing that fall by roughly 1 percentage point relative to no further support being provided, and thereby reducing the fall in real household disposable income by around a third. So the fall in real household disposable incomes in 2022-23 would be half as great again without these measures.
The policy package raises CPI inflation by 0.1 percentage points in 2022-23. This figure reflects the positive impact on inflation from higher demand slightly outweighing the negative impact of the cut to fuel duty and the freezing of the BBC licence fee. The cut to fuel duty that we incorporated into our economy forecast is slightly different to the final policy decision. The Government informed us of the final policy after the deadline for including it in the final economy forecast. Incorporating the final policy would have had less than a 0.1 percentage point impact on our inflation forecast.
As set out in Chapter 3, there is uncertainty over whether and how the energy bill discount and subsequent clawback will affect inflation. We have assumed for this forecast that neither element
will affect official measures of inflation. This may need to be revised in our next forecast once the ONS has issued its classification decisions in respect of each scheme.
This box was originally published in Economic and fiscal outlook – March 2022