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Analytical Challenges in Macroeconomic and Fiscal Policy. Context. Impact of developments over past 24 months (money GDP, £trn):. HMT policy response. Two major fiscal and macroeconomic judgements taken: quantification of the financial crisis’ impact on trend productivity;
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Context Impact of developments over past 24 months (money GDP, £trn):
HMT policy response • Two major fiscal and macroeconomic judgements taken: • quantification of the financial crisis’ impact on trend productivity; • decision about discretionary fiscal stimulus. • Key issues: • how these decisions were taken; • communication and reactions; and • evaluating our actions while addressing new challenges.
Understanding and quantifying the nature of the shock… • Considerations: • is it an impact on supply or demand? - fiscal implications? The Treasury’s adjustment to the path of trend output
…leads to a judgement on the size of the policy response • Even with supply side impact, there was still judged to be a large negative output gap, and a larger nominal demand gap. • This prompted a significant fiscal and monetary policy response: • Bank rate cut to 0.5% and quantitative easing introduced; • Number of financial sector interventions designed to stabilise and restore banking system and flow of credit; • Fiscal stimulus (VAT, capital spending) introduced to stimulate aggregate demand.
External reaction: mixed “Judging it is the right number… is a very difficult thing to do…it seemed to be a reasonable stab at that analysis at this stage” Robert Chote, Institute of Fiscal Studies, TSC Dec 2008 “If you read the section of the PBR where they try to explain and justify this, it really is the worst sort of Noddy economics…no-one has a clue” Roger Bootle, Capital Economics TSC Dec 2008
Fiscal policy response: key considerations • The nature of the financial crisis meant fiscal policy potentially more potent than monetary policy: • fiscal policy transmission can be quicker; • more effective when people can’t smooth consumption in face of credit constraints; • public sector borrowing is effectively substituting for private sector borrowing; • uncertainty argues for multiple instrument approach. • To inform our analysis, we drew on a range of evidence: • Theoretical predictions: e.g Keynesian multipliers; • Model simulations: e.g. examples in Fiscal Stabilisation and EMU, HM Treasury, 2003 • Practical experience: e.g. IMF analysis of German VAT increases in 2007. • The ½% reduction in VAT announced at PBR 2008 met the following key criteria: • timely: Change can be implemented quickly and has a rapid impact on behaviour • temporary : Policy change is reversible • targeted : that the support boosts spending, to maximise the impact on economic activity
External reaction: mixed “The VAT cut appears to have had a clear positive effect” February 2009 ‘Fiscal policy is more effective in a banking sector led recession than it would normally be’, February 2009 “The VAT cut does not seem to me to be a good idea”, Olivier Blanchard, Chief Economist at the IMF. “The temporary VAT cut has about the same effect as a (slightly more than) 100 basis points” January 2009
Conclusions • Policy operates in real-time: analysis needs to keep up with developments; • Lots of new policy introduced: important to evaluate its impact and interaction: e.g. were our behavioural assumptions borne out? • New challenges, e.g. fiscal consolidation and economic rebalancing: how can this be supported by the tax policy?
