MNI: Fiscal Shift Makes BOE Hikes Harder-Think Tank

The UK government's decision to raise labour income tax rates to boost health and social care spending shows it may be hurrying into a premature fiscal tightening, raising the risk that the Bank of England will struggle to escape from the lower bound of interest rates, the research director of the Resolution Foundation think tank told MNI.

While the planned 1.25-percentage-point rise in both employer and employee National Insurance Contributions from next April to fund health and social care spending rises is likely to be broadly economically neutral, it signals an intent to carry out further tightening which could slow growth ahead, said James Smith, a former BOE economist.

The government seems to be assuming that boost to demand from relaxing Covid restrictions and spending of savings accumulated during the pandemic will offset the change in its fiscal stance, but this may be a miscalculation, Smith said in an interview. The Covid pandemic is far from over and there is a risk fiscal support could be turned off before Bank Rate is lifted away from the effective lower bound, he said.

"This is a signalling of tighter policy to come and that is unwelcome," Smith said in an interview. "What you don't want to do is to set your fiscal policy so tight that you leave the Bank marooned at the lower bound as they had been in the run-up to this pandemic."

FISCAL MULTIPLIERS

But the NICs hike in itself will have only a slight macroeconomic effect, even without accounting for the associated increase in spending, according to Rory Macqueen, Principal Economist at the National Institute of Economic and Social Research. And the fiscal multipliers amplifying the effect of both the tax and spending increases are similar, at 0.5 to 0.4, he told MNI, citing NIESR research for February's Budget.

When NIESR, before the 2019 election, modelled the impact of reducing income taxes by some GBP26 billion, about double the size of the planned NICs hike, as well as cutting corporation tax, the rise in GDP was just 0.1% and the hit from a hike is likely to be broadly symmetrical, Macqueen said.

The BOE and NIESR will look in detail at the impact of the tax and benefit changes in their next forecast rounds but fiscal tightening is already in their base cases.

"To some degree yes, it is stimulus coming to an end, but … Chancellor [Rishi Sunak] has been telling us for some time that this stimulus is time-limited and he is planning to consolidate as soon as Covid is over," Macqueen said.