Government fears public finance costs of Covid-19 epidemic could be on par with financial crisis

  • Video report by ITV News Political Editor Robert Peston

UK and Scottish government modelling shows that the economic and fiscal costs of a Covid-19 epidemic could be on a par with the costs of the 2008 banking crisis.

According to a senior government source: "that is what our modelling shows".

If millions were unable to work and significant numbers of businesses unable to trade as usual during an epidemic, there would be a huge automatic rise in Universal Credit and other welfare payments to those quarantined.

Further costs would be incurred from whatever schemes are put in place to shelter otherwise viable businesses from collapse, coupled with any emergency top ups to health and social care spending.

The Bank of England has limited power to help, unlike in the banking crisis. Credit: PA

City sources are calculating the hit to the economy as potentially five per cent of GDP or national income - which would be marginally less than the first year impact of the banking collapses.

But the one year impact on the public finances could be as significant as in the year after the crash, because temporary rises in unemployment and under-employment could be sharper than 12 years ago, forcing up social security payments, while tax revenues would fall very fast.

In 2009, the government estimates the banking crisis added around 6 percentage points to its annual deficit.

The budget, due next week, will set the framework for how the government would seek to mitigate the costs to the economy and public finances.

Businesses remained shuttered after going bust during the 2008 banking crisis. Credit: PA

That said, if there is such an economic shock, the recovery should be much sharper than in 2009, because the financial system should not be hobbled in the way it was then.

Another big difference between 2008 and now is there is a limit to the power of central banks like the Bank of England to revive economic activity during an epidemic, by cutting interest rates and creating money, because cheap money does not end a quarantine.

That said central banks from Japan, to the US and UK have said in the past few days they will do whatever it takes to sustain confidence.

For the avoidance of doubt, the government does not believe an epidemic and severe economic shock are inevitable. But it is planning for the worst.

PS: The public finance forecasts included in next week’s budget books, and prepared by the Office for Budget Responsibility, were handed over to the Treasury a week or so ago.

So the published numbers will not include any addition to the deficit stemming from a potential Covid-19 shock.