MNI INSIGHT: UK Fiscal Multiplier Tricky For BOE, May Be Small

By David Robinson

     LONDON (MNI) - The Bank of England will be left walking a presentational

tightrope when it assesses the size of any boost to the economy from public

spending increases following the Dec. 12 election, but recent research suggests

the multiplier effects of fiscal stimulus may be low in current conditions.

     All major political parties are committed to higher spending, so BOE

officials, who seek to avoid commenting on fiscal policy, will need to make

assumptions on the fiscal multipliers - the ratio of change in output to the

change in discretionary government spending. The Bank has previously not

published anything in detail on these multipliers and the pressure will be on it

to once again stick to broad-brush assumptions to avoid being pulled into the

political morass.

     External studies have explored the idea that fiscal multipliers are not

constant but vary according to variables such as the business cycle, the level

of public debt and the monetary policy stance.

     On this basis the UK fiscal multipliers may, at present, not be that large.

     One paper on the UK by, among others, Giulia Sestieri, Deputy Head of the

Monetary Policy Division at the Bank of France, found that "government spending

multipliers vary over time and that most of the variation is cyclical:

multipliers for GDP are typically above one in recessions and below one in

expansions" and "that the impact of government spending shocks is limited in the

UK in non-recessionary periods."

     Research on OECD countries by former BOE economist Ryan Banerjee and

Fabrizio Zampolli, at the Bank for International Settlements, found that

"estimates of fiscal multipliers are generally below one across a variety of

states" with multipliers generally lower when the output gap was positive,

public debt was high and countries faced a current account deficit.

     --OUTPUT GAP

     The BOE's most recent assessment is that, following recent below trend

growth, a very slight negative UK output gap has opened up, of -0.25% of GDP,

but that this could soon turn positive. The country has high debt levels, a

permanent current account deficit and growth is still just positive, suggesting

that fiscal multipliers at present will not be as high as they could be.

     The BOE's extensive in-house economics staff can be relied on to keep up to

speed on external research but the Bank also has strong reasons not to publish

any material on state of the art fiscal research, as this would risk its being

perceived as judge and jury on fiscal policy.

     In its September minutes the BOE's Monetary Policy Committee seemed to

assume a fiscal multiplier of markedly below one when it stated that the

government's recently-announced stg13 billion increase in departmental spending

limits, equivalent to a little over 0.6% of GDP, could raise output by around

0.4% over its three-year forecast horizon.

     The Office for Budget Responsibility, the official fiscal forecaster, also

uses broad brush fiscal multipliers, assuming a multiple of one for capital

spending increases and just 0.3 for income tax changes.

     MPC members are free to form their own views on the plausibility of any

modelled assumptions of fiscal multipliers.

     In the MPC's November projection, despite the fiscal boost, the level of

GDP at the end of the forecast period was around 1% lower than in the preceding

August report, due largely to asset price movements and the weaker global

environment.

     The MPC's next meeting, ending Dec. 18 with an announcement Dec. 19, would

be too close to the election for it to fully factor in any fiscal changes into

its projections. Forecasts in the Jan. 30 Monetary Policy Report, however, may

be released after a new government has produced a budget.

     The governing Conservative Party, currently well ahead in the polls, has

adopted fiscal rules which would allow it to boost investment spending by an

additional 1% of GDP.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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