The Outlook for U.K. Public Finances
The Long Shadow of COVID-19
August 6, 2020 – It is clear that the COVID-19 outbreak — and the public health response to it — will dramatically reduce U.K. economic activity in the second quarter of 2020. This in turn will depress tax receipts and add to government spending, increasing government borrowing and in turn adding to government debt. The package that, appropriately, the U.K. government has announced to help support public services, households, and employers will also have the direct impact of increasing borrowing. A key issue is how quickly — and how fully — the economy, and with it the public finances, recover over subsequent years.
To look at this further, we set out three scenarios for the outlook for U.K. growth over the next five years and describe what in turn these might mean for government borrowing and government debt. We also provide some guidance on the appropriate fiscal policy response for the U.K. in the short-term, where essentially additional borrowing that will boost subsequent growth is likely to be beneficial given very low interest rates, and in the longer term, where a combination of tax rises and accommodating an elevated level of debt for decades is, perhaps, the most likely outcome.
While there is considerable uncertainty over the path of the economy and the resulting impact on the public finances, it is clear that government borrowing will be substantially increased in 2020–21 and about as certain as it is possible to be with the public finances that it will reach levels not seen since during the Second World War. Even once COVID-19 has passed — and the public health measures put in place to combat it have been largely lifted — it is likely to be the case that the economy will remain impaired for some time.
Given the low cost of borrowing — due to extremely low effective interest rates on government borrowing — further borrowing in 2020–21 which led to a stronger subsequent economic recovery would most likely be worth doing. And it also means that any new policy action that is taken to reduce borrowing need not — and indeed should not — be implemented until the economy is back to a more normal performance. However, the risk to the public finances from elevated debt is that the cost of government borrowing rises and this is not associated with an increase in growth prospects.Authors: Carl Emmerson,Benjamin Nabarro,Isabel Stockton,