Inside the black box: the public finances after coronavirus

In the midst of the Covid-19 crisis, public finances are the focus of intense public attention. The OBR, as well as a leaked Treasury document, suggest that public borrowing in 2020-21 could rise to more than £300 billion. But what does this all mean? Is the UK doomed by high debt? This briefing puts such numbers into perspective. It shows that high borrowing – necessary to fight the crisis – and an increased debt level are manageable in the medium term. This judgement is based on an interactive online tool that allows users to experiment with different assumptions to observe how forecasts of the public finances change in real-time.

The Covid-19 crisis will affect the public finances through higher unemployment, reduced tax revenue and substantial government spending on schemes to support the economy. Already there are calls for a return to austerity once the most acute phase of the medical emergency has passed. It can be difficult for citizens to take a position on these debates: many feel that they lack the technical knowledge.

Forecasts of public debt and deficits play an important role in framing these debates. Media headlines give the impression that higher public debt presents an immediate danger to the financial security of the average citizen. This limits the ability of voters to question their government’s policies on the basis of an informed position on the likely costs and benefits of alternative strategies.

This briefing presents an interactive forecasting tool, which is available to use below. It can also be accessed in full screen view here.

Interactive Forecasting Tool

The tool produces plausible yet easy-to-understand forecasts of the UK’s public finances. Users can alter the lockdown length, ‘rebound’ growth rate in 2021-22, and the medium-term growth rate to observe in real-time how these affect forecasts of the deficit and debt. By experimenting with different settings, users will be able to gain an intuitive understanding of how the public finances are determined.

To illustrate its use, the briefing discusses two scenarios taken from the tool: a three-month lockdown in which growth returns to its pre-Covid level, and a six-month lockdown in which ‘scarring effects’ cause a reduction in the medium-term growth rate. In the first scenario, public debt is expected to rise to around 120% of GDP. In the second scenario, public debt is expected to rise to around 135% of GDP. While there is a considerable amount of uncertainty associated with these forecasts, we can assume with some certainty that the debt-to-GDP ratio will rise above 100% of GDP as a result of the crisis.

These debt levels are elevated compared with recent experience, but they do not imply the need for a return to austerity. This is because the interest rates at which the government borrows are very low by historical standards, and the Bank of England has indicated its continued support for the economy by Quantitative Easing. The briefing discusses recent behaviour of interest rates, and what this implies for the government’s debt service costs in the near future. A more equitable way to place the public finances on a sustainable footing is through progressive taxation, including taxation of wealth. Given that government spending as a share of GDP will need to rise, higher tax shares should be a medium-term policy goal.

While the briefing discusses the policy implications of higher public debt, the interactive forecasting model is designed as a tool for public education, as well as a policy-making guide. It does not, therefore, impose a particular policy conclusion on the user. A healthy democracy requires a public that can question government policy. This is not possible without public education: opening the ‘black box’ of public debt forecasts is a small step in this direction.