The Impact of the Russian Invasion of Ukraine on the UK Economy

Friday, April 1, 2022

Question 1: Relative to the Bank of England’s planned trajectory for interest rates at the beginning of the year, the Bank should respond to geopolitical events by:

Question 2: Relative to the public spending plans at the beginning of the year, the UK government should respond by:

Question 3: Relative to tax plans at the beginning of the year, the UK government should respond by:

How the experts responded

Question 1

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	Raising interest rates more slowly	Confident
Ricardo Reis London School of Economics	Raising interest rates more rapidly	Confident
Jumana Saleheen Vanguard Asset Management	Raising interest rates more slowly	Very confident	The invasion of Ukraine by Russia is creating a human toll and immeasurable suffering. This geo-political event has resulted in high commodity prices and somewhat tighter financial conditions. Higher commodity prices push up UK consumer prices both directly and indirectly. The consensus view is that inflation will rise to 8-9% in April. This lowers household real incomes and pushes down on economic activity. In other words, events in Ukraine are a stagflationary shock to the UK economy. The Bank of England does not set out the trajectory for future interest rates like the Federal Reserve does. Instead, they base their forecast on the market interest rate. On 30 March markets were pricing in another 125bps worth of hikes, which would take Bank Rate to 2.0% by year end. I believe this path is too aggressive and risks creating a recession. Faced with that trade-off between high inflation and low growth the Bank will need to pause the rate hiking cycle.
Martin Ellison University of Oxford	Raising interest rates more rapidly	Confident	The bottom line is that inflation in February 2022 was 6.2%. The Bank of England can argue as much as it wants that it should “look through” transitory inflation but the optics of not responding to such high inflation do not look good. It’s the first time the inflation targeting framework has been tested on the upside, so a mild increase in the speed of tightening is warranted to signal commitment to bringing inflation down.
Chryssi Giannitsarou University of Cambridge, Faculty of Economics	No change	Confident
John VanReenen London School of Economics	Raising interest rates more slowly	Confident
Michael Wickens Cardiff Business School & University of York	Raising interest rates more slowly	Very confident	The Bank is already behind the curve on interest rate increases. The current price rises due to the new and further supply shortages can be seen as the global market's attempt to adjust demand to supply. A reduction, or holding back planned increases, in interest rates would only increase UK demand when what is needed is a fall in demand. This is what the UK did in the 1974 oil crisis which resulted in the UK having higher inflation than other countries. It was later widely acknowledged that this was the wrong choice. The best the UK can do is reduce the burden on poorer families through fiscal policy.
David Cobham Heriot Watt University	Raising interest rates more slowly	Confident	This answer is on the assumption that the war lasts a long time. If not, then returning to the previous trajectory would make sense. Temporary supply-driven shocks should indeed be accommodated, but the MPC should also have an eye on inflation expectations (and might want to consider whether the general fecklessness and incompetence of the UK government could have adverse effects also on the credibility of institutions such as the BoE).
Alessandra Bonf... Queen Mary University of London	Raising interest rates more slowly	Confident
Gino A. Gancia Queen Mary University of London	No change	Confident
Dawn Holland	Raising interest rates more slowly	Very confident	Inflation is still largely driven by energy prices. Since the outlook for energy markets is so uncertain, a wait-and-see approach is more prudent than aggressive rate hikes.
Nicholas Oulton London School of Economics	Raising interest rates more rapidly	Confident
Paul De Grauwe London School of Economics	No change	Confident
Natalie Chen University of Warwick	Raising interest rates more slowly	Not confident
Richard Portes London Business School and CEPR	Raising interest rates more slowly	Confident	Other forces are already affecting demand negatively, and they will intensify. It is unwise to add interest rate pressures, especially since the inflation problem is due to a supply shock which we may reasonably expect to moderate over the course of this year.
Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme	Raising interest rates more slowly	Not confident
Costas Milas University of Liverpool	Raising interest rates more slowly	Confident	As I explain in a recent piece for The Conversation (https://theconversation.com/interest-rates-are-likely-to-rise-by-much-less-than-most-people-are-predicting-179326), pooling information from economic, financial, pandemic and geopolitical risk results in lower interest rates compared to what financial markets currently predict. This is because rising uncertainty will harm UK economic activity.
Linda Yueh London Business School	No opinion or other	Not confident
Lucio Sarno Cambridge University	No change	Confident
Ethan Ilzetzki London School of Economics	Raising interest rates more rapidly	Not confident	The war shock will raise inflation and inflation expectations which should lead to a MODERATE increase in interest rates. This should be balanced against the fact that the war is primarily a supply shock and not due to an overheating economy. This recommendation is CONDITIONAL on the expansionary fiscal policy I recommend below, which should mitigate the social costs of the war shock on the UK economy.

Question 2

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	Increasing public spending in real terms	Confident
Ricardo Reis London School of Economics	Increasing public spending, but less than inflation	Confident
Jumana Saleheen Vanguard Asset Management	Increasing public spending, but less than inflation	Confident	Public spending plans announced in the Spring Statement (23 March) offer additional support to households. Despite this the Office for Budget Responsibility (OBR) project that household real disposable incomes are set to fall by 2.2% in 2022/23 – the largest fall in 45 years! But the support offered to those in the bottom half of the distribution was much lower than to those in the top half. Given that poorer households spend a larger share of their income on in fuel and food, I would like to see the UK government respond by increasing support to the poorest households.
Martin Ellison University of Oxford	No opinion or other	Confident	There is a clear constituency for additional spending that helps the adjustments of those most affected by the shocks. Whether this is funded by an increase in overall spending depends on whether the current generation as a whole is particularly disadvantaged. If they are then there is an argument to increase overall spending. If not then assistance to those most affected should come from within the existing budget. For example, increases in energy prices that reflect responses to global warming are likely to be permanent, so call for within budget adjustments rather than additional overall spending.
Chryssi Giannitsarou University of Cambridge, Faculty of Economics	Increasing public spending, but less than inflation	Not confident
John VanReenen London School of Economics	Increasing public spending in real terms	Confident
Michael Wickens Cardiff Business School & University of York	Increasing public spending, but less than inflation	Confident	See first answer
David Cobham Heriot Watt University	Increasing public spending in real terms	Confident	The original plans, which were in line with the austerity arguments used after 2008 (now widely discredited, mainly by papers from the IMF research department), were already in need of adjustment, and the Ukraine war strengthens the case. At the same time there is a clear argument for tightening public expenditure control, targeting tax cuts and expenditure increases on the poor (including the unemployed), and eliminating favours to friends and supporters of the government.
Alessandra Bonf... Queen Mary University of London	Increasing public spending in real terms	Not confident
Gino A. Gancia Queen Mary University of London	Increasing public spending, but less than inflation	Confident
Dawn Holland	Increasing public spending in real terms	Very confident	The Government's commitment to support local communities that host arrivals from Ukraine will bear a cost, probably requiring an increase in public spending in real terms (although it will depend on the number of arrivals). Low income households will also need support in the face of high inflation.
Nicholas Oulton London School of Economics	Increasing public spending in real terms	Confident
Paul De Grauwe London School of Economics	No change	Confident
Natalie Chen University of Warwick	Increasing public spending in real terms	Not confident
Richard Portes London Business School and CEPR	Increasing public spending in real terms	Confident	Borrow and tax more.
Wouter Den Haan London School of Economics	Increasing public spending in real terms	Not confident	An important motivation for my answer is that an accommodating fiscal policy will be helpful politically in imposing sanctions on the Russian government which will have massive short-term benefits for Ukraine and massive long-term benefits for Europe.
Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme	Increasing public spending, but less than inflation	Confident	This is a diffcult question to answer as set out. Public spending should go up but in particular places - some benefits, support for health and social care, and schools. Local authority settlements will probably need another look. But some items mey merit tight control - pace of some capital spend for example.
Costas Milas University of Liverpool	Increasing public spending, but less than inflation	Confident
Ethan Ilzetzki London School of Economics	Increasing public spending in real terms	Very confident	The cost of living was increasing and living standards were set to decline even before the Russian invasion. This problem has two prongs, one is inflation etching away at households' savings (although also at their mortgages and other debts), the other is that real wages have been stagnant, even well before Covid-19. Redistributive fiscal policy that enhances the social safety net should be supported and increase in real terms. Other investments, such as infrastructure, should focus on productivity growth and increasing real wages in the longer run.
Linda Yueh London Business School	Increasing public spending, but less than inflation	Confident
Lucio Sarno Cambridge University	Increasing public spending, but less than inflation	Not confident

Question 3

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	No change	Confident
Ricardo Reis London School of Economics	Cutting tax rates, but allowing revenues to increase via inflation	Confident
Jumana Saleheen Vanguard Asset Management	Increasing tax rates	Confident	The UK government should consider ways to green the economy through taxation. Gas is the largest source of UK energy accounting for 38% of our primary energy consumption. ‎Second is oil at 35%, and third is renewables at 17%. While UK dependence on Russian oil and gas is small, the UK is not spared from commodity price spikes: the price of oil is global and the price of gas regional. Current demand and supply projects suggest that we are likely to see another spike in energy prices in Autumn/Winter 2022. Speeding up plans to move away from fossil fuels will reduce our vulnerability to future energy shocks and accelerate the transition to net zero at the same time.
Martin Ellison University of Oxford	No opinion or other	Confident	As for spending in the previous question, tax changes should be focussed on where they are most effective.
Roger Farmer University of Warwick	Increasing tax rates	Not confident	It seems clear that public investment is likely to increase both on defense and on social care. I have argued elsewhere that one possible way to finance these expenditures would be to purchase shares in an index fund, finance by gilts, and exploiting the equity premium.
Chryssi Giannitsarou University of Cambridge, Faculty of Economics	Cutting tax rates, but allowing revenues to increase via inflation	Not confident
John VanReenen London School of Economics	No change	Confident
Michael Wickens Cardiff Business School & University of York	Cutting tax rates, but allowing revenues to increase via inflation	Confident	It is essential to allow prices to rise as explained before. And inflation will reduce the real burden of borrowing to fund tax cuts. The question is whether tax cuts are the best way of ameliorating the problems of the poorest. Probably not. Tax cuts are best aimed at increasing general demand and growth, not helping the poorest as they pay little tax.
David Cobham Heriot Watt University	Increasing tax rates	Confident	The increases should be in specific areas including a windfall tax on oil and gas producers, rather than in VAT (regressive) or income (and NI) taxes, and the latter should not be cut. Governments who set aside funds for bribes to the electorate at election time should be ashamed of themselves.
Alessandra Bonf... Queen Mary University of London	No opinion or other	Confident	Selectively increase taxes on top incomes and wealth, given that low and middle earners are going to suffer the larger strain of the supply shock.
Gino A. Gancia Queen Mary University of London	No change	Confident
Dawn Holland	No change	Confident
Nicholas Oulton London School of Economics	Cutting tax intake	Confident	The additional supply shock generated by the Russian invasion of Ukraine should be combated by tighter monetary policy coupled with looser fiscal policy.
Paul De Grauwe London School of Economics	Cutting tax intake	Not confident
Natalie Chen University of Warwick	Cutting tax intake	Not confident
Wouter Den Haan London School of Economics	Cutting tax intake	Not confident	An important motivation for my answer is that an accommodating fiscal policy will be helpful politically in imposing sanctions on the Russian government which will have massive short-term benefits for Ukraine and massive long-term benefits for Europe.
Richard Portes London Business School and CEPR	Increasing tax rates	Confident	Increase taxes on the well off, reverse the NI rise, increase Universal Credit.
Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme	No change	Not confident
Costas Milas University of Liverpool	Cutting tax intake	Confident
Ethan Ilzetzki London School of Economics	No change	Very confident	Let inflation increase revenues to support increased public spending. Households who pay most taxes can afford this. Households who can't afford this should be supported with increased public spending (see my response above).
Linda Yueh London Business School	Cutting tax rates, but allowing revenues to increase via inflation	Confident
Lucio Sarno Cambridge University	Cutting tax rates, but allowing revenues to increase via inflation	Not confident

How the experts responded

Question 1

Question 2

Question 3

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