Ward says at a first glance, the Budget will deliver a significant economic stimulus in through his temporary VAT cut and other measures, but he thinks the form of the package and its temporary nature imply a much smaller positive impact on demand.
Ward says: “Most consumers base their spending on their long-term income expectations, not current earnings. Current income is a key factor only for families with no savings or unable to obtain credit.
“A temporary VAT cut is not targeted at people more likely to spend any windfall gain and has no positive impact on the economy’s long-term supply potential. Consumption will rise in the months before the lower rate is withdrawn but fall by roughly same extent afterwards. The temporarily higher demand will be met either from imports or a rundown of stocks, with no impact on domestic production.
He warns that policies must be designed to enhance the economy’s supply potential, thereby raising long-term income expectations – something he says this package does not do.
“Regardless of whether the effect of Darling’s package is large or small, it will be fully reversed in 2010-11 and beyond as the VAT cut is reversed and higher national insurance and income taxes kick in,” he says. “So it is possible that by 2011 the economy will be no stronger than in the absence of Darling’s measures yet the public finances will be worse.”