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MNI INSIGHT: UK Fiscal Boost May Be 1% GDP, BOE Impact Limited

By David Robinson
     LONDON (MNI) - Additional fiscal stimulus in the UK's March 11 budget could
amount to 1% of gross domestic product, but the practical difficulties of
ramping up infrastructure projects may prevent it from having a decisive impact
on Bank of England interest rate decisions.
     According to a brief reference announcing new fiscal rules in the governing
Conservative Party's election manifesto, public sector net investment will be
restricted an average of no more than 3% of gross domestic product, and the
government would "reassess" debt sustainability plans if interest payments reach
6% of revenue. Full details will be provided by Chancellor of the Exchequer
Sajid Javid on budget day, but analysts expect final definitions of the rules to
maximise its room for manoeuvre.
     With public investment currently running at about 2% of GDP, there is room
for another additional 1%, Arno Hantzsche at the National Institute of Economic
and Social Research told MNI.
     "That would have to be financed by higher borrowing unless there is a
willingness to increase taxes significantly beyond what was there in the
manifesto," Hantzsche said, "A big paradigm shift when it comes to fiscal policy
relative to the last 10 years is that it now suggests that the fiscal framework
allows for higher borrowing in order to fund public investment."
     Previously, the government's rule had merely stipulated that it must
balance spending by the mid-2020s.
     But, while a 1-percentage-point fiscal boost would in theory more than
eliminate the slack in the economy - recently estimated by the Bank of England's
Monetary Policy Committee to be running at 0.25% of GDP -- in practice it can be
difficult to start spending on infrastructure quickly. Such plans tend to run
into obstacles including the need to meet environmental and planning standards,
which take time to deal with before work can begin, on top of the most basic
difficulty of identifying economically-viable projects to start with.
     All else being equal, higher levels of activity would tend to make it more
likely for the Bank of England to run tighter monetary policy unless
infrastructure investment had an offsetting effect by adding to spare capacity
and supply growth. Lags in implementing spending programmes may, however, push
some of the stimulus effect beyond the two-to-three-year monetary policy
horizon, limiting its effect on the Bank's policy deliberations.
     The BOE is also unlikely to rapidly revise its estimates of spare capacity
and potential growth in light of the March Budget. Its annual supply-side stock
take was carried out this month.
     "The impact on the market economy very much depends on the current state of
the business cycle on the current amount of economic slack that there is in the
economy. We think that the macro-economic effect of higher investment would be
close to zero in the case of output being close to potential," Hantzsche said.
     The government could also provide fiscal stimulus other than via
infrastructure spending. The Conservative manifesto promises to raise the
threshold after which employees make national insurance contributions to
GBP9,500 from GBP8,788, potentially reducing the number of people who have to
pay NICs by 400,000.
     While the revamped investment-to-GDP restriction is a fairly clear cap, the
rule placing limits on interest payments offers more get-out clauses. A breach
of the latter would merely require the government to demonstrate that
debt-to-GDP was not on a rising path, an easier task than the previous fiscal
rule's insistence that it be falling. The government can also, as it determines
the precise wording of the rule, give itself more leeway by using net, rather
than gross, interest payments as a proportion of total revenues for the
     The 6% ceiling would be over GBP50bln in 2020/21, rising to GBP56bln by
2023/2, on MNI calculations, using the most recent projections from the Office
for Budget Responsibility. Gross public sector debt interest for 2020/21 is
estimated at just over GBP40bln, and if the government excludes debt interest
payments to the BoE, debt interest would be closer to GBP30bln, leaving around
GBP20 billion headroom, or about 1% of GDP.
     "The key thing is that given low levels of interest rates it would take a
lot of investment to push up significantly the debt interest to revenue ratio so
the binding constraint for fiscal policy will be the ceiling on investment
rather than the debt/interest revenue ratio," James Smith, Research Director at
think tank the Resolution Foundation, told MNI.
--MNI London Bureau; +44 203 865 3829; email:
[TOPICS: M$B$$$,M$E$$$,MC$$$$,MT$$$$,MX$$$$,MFB$$$,MGB$$$]

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