Ray Barrell, who directs NIESR's macroeconomic modeling and forecasting work, discusses NIESR's view of the key macroeconomic and fiscal choices facing the Chancellor at the Budget, both for the short and longer term:
The short term prospects for the UK economy remain weak, with underlying growth only 0.2 per cent per quarter at present. However, the weather-related bounce-back in demand will mean that there is less than a 1 in 20 chance of 2 quarters of contraction. We expect growth of 1.5 per cent this year, which is well below trend, and the output gap to widen further. There is a 1 in 20 chance of output falling this year. Growth should strengthen slightly to 1.8 per cent in 2012, with a 1 in 5 chance of a fall in output.
Per capita real personal disposable incomes fell by more than 1 per cent last year and will do so again this year. By the end of this year real disposable incomes will be lower that at the end of 2008. Consumer spending will, as a consequence, be weak, and a weak housing market will add to that pressure. Unemployment will rise this year, peaking in the middle of the year at 2.6 million people. The loss of skills during the recession will leave a scar on sustainable unemployment; it will be around 300,000 higher than it would have been. But policy could reduce this.
Fiscal consolidation will slow the rate of growth by ½ percentage point per annum this year and next. Our current forecast suggests the Fiscal Mandate will be breached by a cyclically-adjusted budget deficit of one per cent of GDP in 2015-16. But the case for even more fiscal consolidation now is weak as the output gap is around 4 per cent; Delaying fiscal consolidation would boost employment and output. Markets are not perturbed by small changes in deficits. Fiscal consolidation has to take place over the next decade, but this can be achieved by raising output. Growth can be strengthened in the medium term by raising retirement ages, with every year on working lives raising the level of trend output by 1 per cent and improving the budget deficit by 1 per cent of GDP in the long run.
The economic impact of the rise in oil prices
Dawn Holland discussed the impact of the recent rise in oil prices on the UK and global economies. Expectations derived from market prices indicate that about 2/3 of the $30 rise seen since October of last year is expected to be permanent, while the most recent rise in response to the Libyan crisis is viewed as temporary. NIESR estimates that inflation in the UK will be 1 percentage point higher this year as a result of the oil price rise, while GDP will be about 0.3 per cent lower than it would otherwise have been. Most of the output loss is unlikely to be regained.
Higher oil prices generally worsen government finances. They raise direct government oil tax revenues but, through both indexation effects and macro-economic effects, they reduce revenue from other sources and raise expenditure. NIESR estimates suggest that a $20 rise in the oil price would have little net impact on the public finances in the first year; after that it would reduce, not increase, revenues.
The arguments for a "fair fuel stabiliser" are weak. Intervention in the level of fuel duty in order to stabilise prices would effectively mean a move to partially administer fuel prices. This would be both distortionary from an economic perspective, and counter to the government’s long term objectives on carbon emissions.
Richard Dorsett, who recently advised the Work and Pensions Select Committee on youth unemployment, discussed the recent rise in youth unemployment, now close to a million. Unemployment grew rapidly among young people during the recession, accelerating an increase that had been underway for a number of years. By 2010, nearly one in five under-25s - more than 1.4 million people - was neither working nor a full-time student.
It is well-established that unemployment when young can impose lasting damage on subsequent employment and earnings prospects. Young people without qualifications are particularly disadvantaged, with nearly two in every five neither working nor a full-time student.
Policy appears inadequate given the scale of the problem; from next month, there will be no new entrants to the Future Jobs Fund, while the new Work Programme (scheduled to start in the summer) is anticipated to serve fewer than 100,000 unemployed young people each year.
International evidence points to the difficulty of developing effective policies to tackle youth unemployment. While job search assistance and wage subsidies appear the most successful strategies, there is little evidence of work placements or work experience boosting employment. The government should consider measures to provide explicit or implicit wage subsidies to employers hiring young people.
It will be important to ensure that those individuals who face particular obstacles to employment can benefit from the increased focus on apprenticeships. In the longer-term, we welcome the increased employment incentives arising from the fact that, unlike the Working Tax Credit, under-25s will be eligible to receive the Universal Credit.
Notes to editors:
Macroeconomic policy choices and economic prospects
For further information contact:
Macroeconomic policy choices: Ray Barrell at firstname.lastname@example.org or 0207 654 1925
Oil prices: Dawn Holland at email@example.com or 0207 654 1921
Youth unemployment: Richard Dorsett at firstname.lastname@example.org or 0207 654 1940
Other general Budget and economic issues:
Jonathan Portes at email@example.com or 07766441148