Britain’s economy could shrink by 35% in the second quarter and see unemployment jump by two million, according to a scenario published by the Office for Budget Responsibility (OBR).

The Office for Budget Responsibility has today released an initial exploration of the possible impact of the coronavirus outbreak on the public finances.

While they say that they do not attempt to predict how long the economic lockdown will last and that is a matter for the Government, informed by medical advice, they have illustrated some of the potential fiscal effects assuming a three-month lockdown “due to public health restrictions followed by another three- month period when they are partially lifted”. They say that “for now, we assume no lasting economic hit”.

The Office for Budget Responsibility said that based on an assumption that the current lockdown would last for three months, “real GDP falls 35 per cent in the second quarter, but bounces back quickly and that unemployment rises by more than 2 million to 10 per cent in the second quarter, but then declines more slowly than GDP recovers”. For reference, the unemployment rate currently stands at 3.9%.

The OBR stressed that its figures represented a “scenario rather than a forecast” based on the assumption that people’s movements would be “heavily restricted for three months and would get back to normal over the subsequent three months”.

The OBR say that “evidence from past pandemics suggests that the economic impact of the coronavirus will arise much less from people falling ill or dying than from the public health restrictions and social distancing required to limit its spread. This will reduce demand for goods and services and the ability of businesses and public sector institutions to supply them. That means lower incomes, less spending and weaker asset prices, all of which reduce tax revenues, while job losses will raise public spending”.

They suggest that the “net effect of the coronavirus impact and the policy response is likely to be a sharp (but largely temporary) increase in government borrowing that will leave public sector net debt permanently higher as a share of GDP. However, the longer the period of economic disruption lasts, the more likely it is that the economy’s future potential output will be ‘scarred’ (thanks to business failures, cancelled investments and the unemployed becoming disconnected from the labour market). If that happens, the budget deficit would reverse less of its temporary rise as economic activity recovers, leaving the Government to confront a larger structural deficit and not just higher debt. Before the impact of the coronavirus became clear, the Government was content to run an ongoing deficit that would broadly stabilise the debt-to-GDP ratio over the medium term rather than reduce it – a judgement that it will no doubt re-visit in the wake of the current crisis”.

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