Coronavirus lockdown to deliver large (but hopefully temporary) shock to the economy and public finances, says analysis

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OFFICE for Budget Responsibility has published an illustrative scenario showing how the economic disruption associated with the spread of the coronavirus – and the Government’s policy response – might feed through to the public finances.

Describing one economic scenario where the lockdown lasts for three months, the Office states that in addition to its impact on public health, the coronavirus outbreak will substantially raise public sector net borrowing and debt, primarily reflecting economic disruption.

The Government’s policy response will also have substantial direct budgetary costs, but the measures are designed specifically to support individuals and businesses through this temporary shock and so they should help prevent greater economic and fiscal damage in the long term.

Evidence from past pandemics suggests that the economic impact of the coronavirus will arise much less from people falling ill or dying than from the public health restrictions and social distancing required to limit its spread.

This will reduce demand for goods and services and the ability of businesses and public sector institutions to supply them.

That means lower incomes, less spending and weaker asset prices, all of which reduce tax revenues, while job losses will raise public spending.

The key assumptions and findings of the commentary were:

  • Real GDP falls 35 per cent in the second quarter, but bounces back quickly. Unemployment rises by more than 2 million to 10 per cent in the second quarter, but then declines more slowly than GDP recovers. Policy measures support households and companies’ finances through the shock.
  • Public sector net borrowing increases by £218 billion in 2020-21 relative to the Office’s March Budget forecast (to reach £273 billion or 14 per cent of GDP), before falling back close to forecast in the medium term. That would be the largest single-year deficit since the Second World War.
  • The sharp rise in borrowing this year largely reflects the impact of economic disruption on receipts (with smaller effects from policy measures like the business rates holidays) and policy measures that add to public spending (with smaller effects from higher unemployment).
  • Public sector net debt rises sharply in 2020-21 thanks to lower GDP, higher borrowing and the accounting consequences of the Bank of England’s policy measures. It surpasses 100 per cent of GDP during the year, but ends it at 95 per cent (versus 77 per cent in the Budget forecast) as the economy recovers. It remains 10 per cent of GDP above the Budget forecast in 2024-25.

 

The entire report can be read here