Coronavirus (COVID-19) economic stimulus options: who has the policy levers?

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In response to this crisis, governments and central banks worldwide have enacted significant fiscal and monetary stimulus measures to counteract the disruption caused by coronavirus and help restart their respective economies.

Devising an economic policy response in Scotland is complicated by the fact that responsibility for the economy is shared between the Scottish and UK Governments. This blog explores economic stimulus options (monetary and fiscal) and broadly how these align with both the responsibilities of the Scottish and UK Parliaments. This blog is drafted from an economic policy perspective and should not be interpreted as a legal interpretation of reserved and devolved powers.

Monetary policy measures are driven by the Bank of England and UK Parliament

Monetary policy measures are outwith the power of the Scottish Parliament and Scottish Minsters. Monetary policy measures are driven by the Bank of England and UK Parliament. Monetary stimulus measures can include interest rate cuts, loans and asset purchases (e.g. quantitative easing, repo operations) and regulation changes.

Since the onset of COVID19, the Bank of England has significantly loosened monetary policy to support demand in the economy, provide access to finance and stabilise the financial system. For example:

  • The Bank of England cut its benchmark interest rate twice by a total of 0.65 percentage points to a record low of 0.1%.
  • The Bank has also restarted Quantitative Easing, expanding its holding of UK Government bonds and non-financial corporate bonds by £300 billion. Quantitative Easing is where the Bank creates new money to buy government and corporate bonds in the open market. The idea is to support the price of bonds and thereby reduce interest rates, because yields fall as prices rise. Lower interest rates are intended to stimulate spending and investment as saving becomes relatively less attractive.
  • The Bank introduced a new Term Funding Scheme to reinforce the transmission of the rate cut, with additional incentives for lending to the real economy, and especially SMEs. This scheme offers loans from the Bank of England to banks using the banks’ loans to businesses as collateral for the central bank.

Other monetary measures pursued across the UK include: the Bank of England activating a Contingent Term Repo Facility to complement the Bank’s existing sterling liquidity facilities; launching the COVID Corporate Financing Facility (CCFF), and reducing the UK countercyclical buffer rate to 0 percent from a pre-existing path toward 2 percent by December 2020.

What are fiscal stimulus measures?

The initial fiscal response to the COVID-19 crisis, in economies across the world, saw the issuing of state loans or credit guarantees for companies, income subsidies for affected workers, tax deferrals, income support measure, liquidity support for affected businesses, social security deferrals or subsidies, and debt repayment holidays.

Lockdown was not thought to be the right time for big fiscal stimulus, as people were unable to get out and spend. However, as economies restart these type of stimulus measures will become more important to boost confidence and get money circulating.

A review of the IMF COVID19 Policy Tracker illustrates the vast range of fiscal measures that can be considered. Examples of fiscal measures used to stimulate economies worldwide include: tax incentives for real estate improvement; spending on infrastructure (including on green projects such as retrofitting houses to improve energy efficiency); staycation subsidy to boost domestic tourism; reducing regulatory barriers, such as simpler temporary rules for financial restructuring of companies; initiatives for green jobs and summer jobs for young people; and temporary reductions of the VAT rate of specific sectors. The Institute for Government has created a helpful summary of fiscal stimulus policies by seven broad categories.

  • Cutting taxes on consumption such as VAT, these can be for specific goods or sectors, or across the board. Temporary VAT cuts can be more effective because they give people an incentive to spend now before prices rise again in future.
  • Subsidies for specific goods and services. These types of incentives can be used to encourage spending that contributes towards strategic aims (e.g. a push for net zero emissions could include payments for upgrading older vehicles for electric ones) or is targeted at sectors (e.g. housebuilding and renovation subsidies).
  • Cash incentives/direct stimulus options could include distributing spending coupons that can only be spent on local companies, and expire after a few months, incentivising recipients to spend the money now. Or could include lump sum payments to those on lower incomes.
  • Wage subsidy policies can act as the stimulus as they help maintain incomes and jobs, giving people more money to spend. The UK government’s wage subsidy policy – the Coronavirus Job Retention Scheme is currently due to be phased out in October.
  • Retraining programmes to support the unemployed. These could be linked to certain sectors, such as green industries.
  • Business tax cuts can be used to incentivise companies to hire more staff or invest. This could include increasing the size of tax-deductible allowances for investment or research and development or reducing employer national insurance contributions for newly hired staff to encourage companies to take on more employees.
  • Increase public spending on infrastructure, such as housing, broadband, and transport. This can help by using up otherwise unused capacity in these industries.
What fiscal stimulus works?

The Scottish Government publication ‘UK Fiscal Path – A New Approach’ highlights that successful discretionary fiscal stimulus should be: timely to boost spending quickly; targeted in that they achieve a large increase in spending in the short-term at minimal cost to the public purse; temporary where the policy can be withdrawn once change has been achieved; and transformative to achieve economic recovery. 

The Economic Observatory tells us that in the short run structural investment is necessary to get people back to work and stimulate domestic spending and demand. In the long run, structural investment in key assets increases their resilience to future shocks, expands capacity and fosters productivity growth. However, the Institute for Government highlights that a key problem with using infrastructure as a stimulus is that projects take too long to get off the ground, and do not create jobs immediately or help businesses fast enough to contribute to the recovery.

Some commentators suggest that sector-specific stimuli may generate the largest economic impacts per pound spent. This suggests the best way to maximise the impact of fiscal stimulus is to identify sectors that are not easily substituted. For example, in some countries dining out schemes may actually reduce supermarket shopping, generating less aggregate demand.

Stimuli could also connect to longer term policy objectives, including building resilience to health risks, decarbonisation and other areas where positive spillovers exist. A strong theme across economies has been calls to match COVID-19 economic stimuli with climate fight ambition and use post-coronavirus economic recovery plans to accelerate investments aimed at tackling the climate crisis. This could include: new cycle lanes, public transport investment, incentives to transition to electric vehicles and associated electric vehicle infrastructure, and retrofitting existing housing stock. On this topic the Economic Observatory highlights that in the short run, clean energy infrastructure is particularly labour-intensive, creating twice as many jobs per pound spent than fossil fuel investments. Construction projects like insulation retrofits and building wind turbines are potentially less import-intensive than many traditional stimulus measures and lead to higher multipliers, while lowering longer-term energy costs.

Fiscal stimulus and the role of the Scottish and UK Governments

As already highlighted, responsibility for the Scottish economy is shared between the Scottish and UK Governments. While the Scottish Parliament has expanded fiscal powers over recent years, the UK Government has a central role in determining economic policy as many economic levers are reserved to Westminster, such as monetary policy and a range of tax powers. Furthermore, the UK Government has a role in determining the Scottish Budget through the Fiscal Framework. While new powers allow the Scottish Parliament to use its taxation powers to increase or decrease the budget available, the starting point for the Scottish Budget is still determined by the size of the block grant.

Revisiting the seven broad categories of fiscal stimulus measures outlined above, we now explore where we might expect either or both the Scottish and UK Governments to act.

  • Cutting taxes on consumption, such as VAT, are outwith the powers of the Scottish Parliament and fall to the UK Parliament. VAT is a reserved tax and the Scottish Parliament does not have power to influence the UK’s VAT rate.  
  • Wage subsidy policies, such as the Coronavirus Job Retention Scheme introduced by the UK Government, fall within the remit of the UK Government given employment is a reserved matter. However, it is worth highlighting here that in the past the Scottish Government has funded recruitment incentive programmes for young people.
  • Business tax cuts that can be used to incentivise firms are mainly a reserved matter. While non-domestic rates are set by the Scottish Parliament, other business-related taxes such as Corporation tax, National Insurance, VAT, and Capital Gains tax are reserved to Westminster.
  • Subsidies for specific goods and services would depend on whether the targeted sector and good/service fall within reserved or developed powers. Devolved matters to the Scottish Parliament, include environment and housing, thus there would be scope to introduce initiatives in these areas.
  • Cash incentives/direct stimulus options again would depend on whether the targeted sector and good/service fall within reserved or developed powers.
  • Retraining programmes are a devolved matter, as the Scottish Parliament has powers in education, training, and skills.
  • Public spending on infrastructure would depend on whether the targeted area was a reserved or devolved matter. Notwithstanding the budgetary constraints outlined below, the Scottish Government has infrastructure powers around housing, some aspects of transport, and even broadband which, although a reserved area, the Scottish Government has used its economic development powers in the past to intervene in this area.

The above illustrates the shared responsibility of both the Scottish and UK Governments over the Scottish economy and the range of fiscal options open to both governments.

Budgetary considerations for fiscal stimuli

While we have outlined above some of the fiscal stimulus options that the Scottish Government has scope to use, budgetary constraints need to be bourne in mind when considering the Scottish Government’s ability to deliver economic stimulus.

As already highlighted, the UK Government has a role in determining the Scottish Budget through the Fiscal Framework, where a proportion of the Scottish Budget is still determined by the block grant received from the UK Government via the Barnett formula. In addition, the Scottish Government has limited borrowing powers and can borrow up to £450m per annum for capital investment (a cap of £3bn overall). On resource spending, they can borrow up to £600m per annum (a cap of £1.75bn), but only for ‘forecast error’ and ‘cash management’. They cannot borrow to fund discretionary resource spending. The Fraser of Allander Institute highlight that whilst the Scottish Government might not be borrowing much more this year than planned, the Scottish economy is effectively being supported by additional borrowing worth around 5% of Scottish GDP via the UK Government. They note it is important to differentiate between borrowing by the Scottish Government (via the Fiscal Framework) and borrowing by the UK as a whole which is then used to support the Scottish economy (and the Scottish Budget).

On the role of the UK Government in determining the Scottish budget and borrowing powers, the Scottish Government stated:

“This restricts our ability to effectively plan our response as our funding position is not clear until the UK Government has finalised its own funding decisions which might be too late”.

Alison O’Connor, Senior Analyst, Financial Scrutiny Unit