From the TUC

Higher Multipliers & the UK: Some Quantification

15 Oct 2012, by Guest in Economics

I presume after last week’s extensive coverage of the issue, most readers are now thoroughly bored of the concept of the fiscal multiplier. But, on the off chance a reader or two is still with me, I thought it might be worth one more post on what is a very important issue.

The debate so far was summed up incredibly well by Jonathan Portes over the weekend.

I really only have one thing to add – some rough quantification of the impact of higher multipliers on the UK. The Observer this weekend ran an excellent article picking up on TUC research in this area, which I’ll summarise below.

As was revealed last week, the OBR, in June 2010, summarised its view on the multipliers as follows:

Change in VAT: 0.35
Change in personal tax and NICS: 0.3
Change in welfare spend: 0.6
Change in departmental spending: 0.6
Change in capital spending: 1.0

By contrast the IMF now believes they are between 0.9 and 1.7.

This raises two important questions – the first is – will the OBR revise its view? The second, as raised with Danny Alexander and Oliver Letwin by the SMF’s Ian Mulheirn,  is, if the OBR had given more downbeat assessments in June 2010 would Coalition policy have been different? Knowing what we known, would different decisions have been made?

This is where a little quantification is helpful.

Back in June 2010 the government set out a fiscal consolidation plan which involved tightening fiscal policy (cutting spending and raising taxes) by the following amounts over the Parliament (expressed a percentage of GDP):

What impact did the OBR assume this would have on GDP, i.e. how much did the OBR believe in June 2010 this would reduce growth by?

To work this out we need, to apply the different multipliers the OBR used to the different components of the fiscal plans for each year. This works out as around 0.6 for most years although is higher in 2010/11 (due to an assumed fall in capital spending in 2010/11 (capital spending had previously been brought forward by the last government)).

We can then essentially back engineer using the fiscal plans as set by the treasury and the multiplier estimates as set out by the OBR, the estimated impact of fiscal consolidation on growth at the time when the government set out its strategy.

This is summarised below:

The OBR believed that austerity would knock 0.5% off growth in 2010/11, 1.3% in 2011/12 and so on. Painful, but manageable if the rest of the economy was growing as it hoped.

But what would these numbers have looked like if the OBR had used higher estimates of the multiplier? The table below compares the OBR June 2010 estimates of the impact of the fiscal pain, to what those estimates would have been with an assumed multiplier of 0.9 (the low end of the IMF new estimates), 1.3 (the mid range) and 1.7 (the top end of the new IMF estimates).

As we can see the picture is very different, in 2011/12 for example (the financial year that ended in March this year) the OBR had assumed that growth would be reduced by 1.3% by austerity policies – but if they had used the midpoint in the new IMF estimates they would have instead estimated an impact of 2.7% on GDP.

How would the OBR’s growth estimates have looked under these different scenarios? The chart below, takes the OBR’s growth estimates of June 2010 and applies the impact of higher multiplier assumptions.

The impact on growth of using a higher multiplier is significant.

With a low multiplier estimate the OBR believed growth would be above 2.5% per year fro most of this Parliament (the blue line at the top). If they had taken the midrange of the new IMF findings, they instead would have forecast growth below 2% until 2015/16 (the green line).

Although in each case the OBR would still have forecast no double dip, the picture of recovery would have been much weaker. Cumulatively, from 2010/11 until 2015/16, a multiplier of 0.9 would have reduced the growth forecast by 2.2% of GDP, a multiplier of 1.3 would have reduced it by 5.2% and a multiplier estimate of 1.9 would have reduced the growth forecast by 8.3% of GDP.

Of course austerity is not the only problem holding back the economy at the moment that the OBR failed to forecast in June 2010 (and forecasts are ofcourse never perfect!) – in particular 9and for understandable reasons) they did not predict the intensification of the Eurozone crisis nor the rise in inflation that added to the squeeze on household incomes.

The rise in global inflation in 2011 and the impact of events in Europe were always going to weaken the recovery, but fiscal policy may be the difference between weak growth and outright contraction.

Note: If anyone is especially interested in this – just leave a comment, I’m happy to send over the spread sheet of data and calculations.   

One Response to Higher Multipliers & the UK: Some Quantification

  1. Oxford Kevin
    Oct 15th 2012, 11:03 am

    Since the UK economy has consistently underperformed the eurozone economies surely it is more correct to say that the UK economy has been a drag on the eurozone economies rather than the other way round.

    Could we from your calculations estimate the impact that this would have on government revenue, unemployment and government spending on welfare benefits for the different estimates of the multiplier?

    There certainly seems room to suggest that the multipliers are at the upper end of the recent IMF estimates. That surprise, surprise the IMF is still being conservative.