The Economy Summary is part of our Weekly COVID-19 Bulletin, sent every Thursday. You can sign up to receive your copy here.
During last week’s Budget, the Chancellor tried to balance the support provided to the economy with the need to begin the work of fixing our public finances. As expected, the Chancellor extended existing support, such as the job support schemes, the Universal Credit uplift, business rate holidays and VAT cuts to reflect the cautious reopening of the economy set out in the roadmap.
While some argued that the Universal Credit uplift should have been extended beyond the six months announced, others welcomed the increase in generosity of the self-employed scheme. Given the different impact on different sectors of the economy, the targeted Restart Grants to the sectors worst hit by restrictions have been much welcomed by small firms in the hospitality industry with cash problems. The Chancellor also announced a new Recovery Loan Scheme that will provide lenders with a guarantee of 80% on eligible loans.
Further ahead, in April 2023, the rate of corporation tax paid on company profits will increase to 25% on profits over £250,000. To soften the blow, the Chancellor announced that for the next two years, companies can reduce their tax bill when investing via a ‘super deduction’ of 130% of the cost. He also froze income tax thresholds from next April for four years, which is considered a good way for the Government to raise revenue without causing economic distortion.
The Office for Budget Responsibility (OBR) thinks the economy will ‘bounce back’ in the near-term as restrictions are eased. The OBR expects growth to return from Q2 2021, with GDP forecast to reach pre-Covid levels earlier than previously expected and unemployment to be better than forecast.
When Commons Treasury Committee members talked about the huge stimulus package in the US and asked if the Chancellor did enough to stimulate growth, the OBR committee member and former Bank of England deputy governor Sir Charlie Bean explained that the size of the output gap is difficult to measure because the response to the pandemic has involved pushing down on both demand and supply in roughly equal measure. As the restrictions are eased, he expects both of them to come back.
In its central forecast, the OBR does not think there is that large a margin of spare capacity, the output gap is quite small, so it would not make sense to have a large demand stimulation. He mentioned that in respect to the Biden plan in the US, many economists who are generally in favour of greater use of fiscal policy think the size of the stimulus is far too big relative to the likely size of the output gap.
If you are considering supporting demand, it is not obvious that there needs to be substantial policy stimulus at this point. It might turn out that this is wrong, and that demand does not recover as quickly as supply, in which case it will be sensible for either the Bank of England or the Chancellor to add additional stimulus. But as things are at the moment, the margin of spare capacity is expected to be quite small during the reopening phase of the economy.
While the Financial Secretary to the Treasury previously said that if the economy is strong, they might not need to raise taxes to fix public finances, Sir Charlie Bean told MPs on the Commons Treasury Committee that the important thing here is not so much slightly faster growth next year but really the scarring assumptions. If they do not see a high level of scarring, then the same sort of fiscal consolidation is not needed in the medium-term. Equally, if the scarring turns out to be greater than they expect, potentially more consolidation will be required. OBR’s central assessment is 3% medium-term scarring, but that number could go either way.