## 1gbrea2024002 ## Source details **Canonical URL:** [1gbrea2024002](https://www.imf.org/-/media/files/publications/cr/2024/english/1gbrea2024002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1gbrea2024002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1gbrea2024002.pdf.json) --- ### Policy Rates, Inflation, and Inflation Expectations - BoE tightening cycle - Bank of England raised interest rates 14 consecutive times between December 2021 and August 2023. - Bank Rate reached a peak of 5.25 percent in August 2023 and has been held at 5.25 percent since then. - Cycle duration: as of May 2024, lasts 30 months (starting from December 2021). - Cumulative increase in Bank Rate over the current cycle: 5.15 ppt. - Inflation and expectations - Headline inflation peaked at around 10–11 percent in late 2022/early 2023. - Headline inflation fell to 2.3 percent in April 2024. - Headline inflation is expected to durably return to the 2 percent target in early 2025. - Market-implied 5-year ahead inflation expectations (adjusted for the RPI–CPI wedge): around 2.5 percent. - Long-run inflation expectations: well-anchored throughout the tightening cycle. - Real rates: only became comparable with previous cycles in Spring 2023 due to record-high inflation earlier in the episode. - Comparison with previous UK tightening cycles (selected metrics) - 1999-Sep to 2001-Jan: Duration 17 months; Total Rate increases 1 ppt; # of Rate Hikes 4; Inflation (highest) 1.3%; Inflation (lowest) 0.6%. - 2003-Nov to 2005-Jul: Duration 21 months; Total Rate increases 1.25 ppt; # of Rate Hikes 5; Inflation (highest) 2.4%; Inflation (lowest) 1.1%. - 2006-Aug to 2007-Nov: Duration 16 months; Total Rate increases 1.25 ppt; # of Rate Hikes 5; Inflation (highest) 3.2%; Inflation (lowest) 1.7%. - 2017-Nov to 2020-Feb**: Duration 28 months; Total Rate increases 0.5 ppt; # of Rate Hikes 2; Inflation (highest) 3.2%; Inflation (lowest) 1.3%. - 2021-Dec to present***: Duration 30 months; Total Rate increases 5.15 ppt; # of Rate Hikes 14; Inflation (highest) 11.1%; Inflation (lowest) 2.3%. - Note: Length measured from first rate hike to last month before first rate cut; current cycle scale commensurate with unprecedented size of the inflation shock. - Macroeconomic and sectoral effects so far - Real GDP growth: much weaker than in all previous cycles. - Drivers: supply constraints (pandemic-related global supply disruptions), terms-of-trade shock from energy price surge related to Russia’s war in Ukraine, and labor shortages. - Domestic demand: household consumption weakened substantially and is a major contributor to weak GDP growth; investment has held up better, including public investment. - Monetary transmission: largely mirrored previous episodes and other advanced economies except mortgage channel slower due to higher share of fixed-rate mortgages. - External spillovers and policy-path implications - Fed announcements have an outsized impact on UK financial markets; premium on BoE communications when BoE may diverge from Fed. - Model-based predictions of optimal UK rate paths are close to staff’s recommended path in the 2024 Article IV consultation. - If BoE places high weight on risk of de-anchoring of inflation expectations, model results indicate a slower pace of cuts would be warranted. ### Annex I — Micro underpinnings of consumption weakness and investment strength - Monetary transmission — FCI and channels - Financial Conditions Index: initial impact somewhat stronger than previous cycles but eased recently (elasticity of FCI to cumulative rate increases). - Interest rate channel - Response of “new” bank lending rates (corporate and household loans) similar to previous cycles. - “Effective” rates on corporate loans and household non-mortgage loans consistent with previous cycles. - Increase in “effective mortgage rates” significantly undershot previous cycles due to higher share of fixed-rate mortgages; passthrough of corporate bond yields settled at around 0.7. - Gilt yields more responsive to policy rate increases than previous cycles. - Asset price channel - Equity prices (FTSE100) have held up relatively well. - House prices more subdued — potentially contributing to weaker household consumption via wealth effects. - Credit channel - Bank lending has almost remained flat in the current cycle, a clear break from the past. - Corporate capital issuance volatile but not significantly different from previous cycles. - Macro and cross-country comparisons - GDP growth notably weak compared with previous tightening cycles, largely reflecting weak consumption; investment resilience stands out. - Controlling for size of tightening, UK’s weak GDP and consumption response comparable to other countries; stronger investment is distinctive. - Fiscal deficits relatively larger than peers, reflecting stronger COVID support. - Wage growth similar to peers but more persistent, likely due to tighter labor market. - Real effective exchange rate: initially depreciated and has appreciated in recent quarters, driven by interest rate differentials with the US. - FOMC spillovers, timing, and market example (December 13–14, 2023) - FOMC signaled potential 75bps rate cuts in 2024 on December 13, 2023 (after UK markets closed). - On December 14, the 2-year gilt yield dropped 20 bps within 15 mins after market opened. - BoE MPC announced a hawkish hold later that day (three out of nine members voting for a further rate hike) with no press conference; markets still expected more than 100bps of rate cuts in 2024 (up from 75 bps the day before). - The 2-year gilt yield increased 3 bps within 30 minutes around the MPC's announcement. - MPC meetings: five per year in 2023 and 2024; decisions announced one day after FOMC’s decisions; three of them did/do not have press conferences. - Historical back-to-back meetings: 41 FOMC announcements occurred one day before MPC announcements from 1999 to mid-2023. - Identification, factor structure, and empirical approach - High-frequency market movements around policy announcements used to identify monetary policy surprises (methodology references). - Data: UK Monetary Policy Event-Study Database (UKMPD); monthly data for LP-IV analysis: 1997 June to 2019 December. - Factor analysis: three MPC factors (Target, Path, QE) and two FOMC spillover factors (Spillover 1, Spillover 2). - Correlations: MPC factors and FOMC spillovers can produce opposing shocks on the same day. - Regression evidence on FOMC spillovers (N = 41) - Spillover 2 associated with slight depreciation of sterling against the dollar: USD/GBP coefficient: -0.082***; R2 = 0.124; N = 41. - Spillover 1 coefficients: mixed, generally insignificant for equity indices and exchange rates. - Notes: GBP/EUR is value of British pound per euro (an increase indicates sterling depreciation); USD/GBP is value of US dollar per British pound (an increase indicates sterling appreciation). Significance: * p<0.1, ** p<0.05, *** p<0.01. - Interpretation: FOMC forward guidance can push up long ends of US and UK yield curves, widen interest rate differentials, and lead to sterling depreciation versus the dollar; limited impact on UK stock markets or GBP/EUR. - Macro effects of MPC shocks (LP-IV) - Baseline impulse response to a 100-bps increase in Bank Rate (Target shock): - Leads to about 1.2 percentage points decline in real GDP within 30 months. - Effect persistent and remains about 1–1.2 percentage points 36 months after the shock. - Confidence bands: 68 percent and 90 percent. - Including FOMC spillovers: strengthens monetary transmission by pushing forward GDP impact; peak impact reaches about six months earlier compared with baseline without FOMC shocks. - Caveats: few observations since 2021; COVID volatility adds noise; current cycle exhibits abnormalities where FOMC spillovers can work against MPC objectives. - Policy communication and operational recommendations for the MPC - Current practice (MPC makes decision before FOMC but announces after markets absorb Fed decision) may be suboptimal. - Recommended adjustments: - Consider streamlining information published alongside MPC decision to enable announcement on the same day. - Consider delaying publication of MPC minutes and the MPR by about a week (analogous to FOMC practice). - Consider holding a press conference after each MPC decision to elaborate or caveat views when market reactions to FOMC decisions are inconsistent with MPC’s intended direction. ### Model-based alternative monetary policy paths (COPP toolkit and optimality) - Toolkit and model - COPP toolkit (De Groot et al. (2021)) with Svensson (2000) semi-structural open economy model (Phillips curve, IS curve, UIP). - Model calibrated to match estimated transmission from VARs for advanced economies (impulse responses to a 100bps monetary policy shock shown in Figure 7 in source). - Optimality objective and loss function - Quadratic loss function: - L = E_t Σ_{t=0}^∞ [ λ_π (π_t − π^*)^2 + λ_y (y_t − y^*)^2 + λ_i (i_t − i_{t-1})^2 ] - Weights and Loss Function (relative to staff projection) - Baseline: λ_π = 1, λ_y = 1, λ_i = 1 → Loss Function (relative to staff projection) = 0.53 - High Inflation Weight: λ_π = 5, λ_y = 1, λ_i = 1 → Loss Function (relative to staff projection) = 0.66 - High Output Weight: λ_π = 1, λ_y = 5, λ_i = 1 → Loss Function (relative to staff projection) = 0.54 - High Interest Rate Weight: λ_π = 1, λ_y = 1, λ_i = 5 → Loss Function (relative to staff projection) = 0.56 - Benchmarks and simple rules - Taylor Rule I: coefficient of 0.9 on lagged Bank Rate (S), 1.5 on annual CPI inflation (π), 1 on output gap (y). - Taylor Rule II: coefficient of 0.75 on lagged Bank Rate, 2 on annual CPI inflation. - Optimal policy projections vs staff baseline - Staff baseline projection close to optimal but differs in timing of rate cuts. - Optimal interest rate policy suggests much earlier reduction in the policy rate, followed by period of rates around 4 percent in 2025-6. - Under all loss function assumptions, inflation converges to the 2 percent target by 2025. - De-anchoring risk and constrained optimal policy - De-anchoring assumption: fraction a = 0.5 of agents have perfect foresight with inflation expectations at target; fraction decays at exponential rate each quarter. - Under de-anchoring risk, constrained optimal policy moves closer to staff baseline (more gradual normalization), but still incentive to normalize interest rate quicker than baseline given negative output gap. - Targeting core inflation - Targeting core inflation (more domestically-generated) shows higher inertia and increases the trade-off between inflation and output stabilization. - Constrained optimal policy path remains similar to baseline targeting headline inflation; "cut, hold, cut" prescription robust to higher inflation inertia. ### Micro underpinnings — household consumption and investment dynamics - Consumption - Drivers of weak household consumption: high cost of living and weak consumer confidence. - Bank of England/NMG household survey (2019–2023 findings) - 2019 to 2022: general increase in median consumption across all income groups due to higher costs of living; higher consumption financed largely by withdrawal of savings or more borrowing (more likely for lower income group). - 2022 to 2023: across-the-board increases in household income largely saved — likely due to weak consumer sentiment. - Mortgage channel - Less than 30 percent of households in the survey have mortgages. - About 50 percent of households in the highest income group have mortgages; less than 10 percent in the lowest income group. - Distribution of mortgages subject to repricing each year follows similar pattern. - Larger increases in mortgage payments observed in lower income groups in 2022 (Group 1) and 2023 (Group 2) likely due to other factors (such as new mortgages) rather than repricing of existing mortgages. - Near-term outlook: flows of fixed-rate mortgages being repriced not expected to be a major drag on consumption; continued strong wage growth and improving consumer sentiment likely support consumption recovery. - Investment - Business investment picking up after long period of stagnation. - Firm-level Worldscope data (asset-weighted) - 2019–2022: Utilities and communications sectors had highest increases in capital expenditures; manufactures declined. - 2022–2023: strong investment in utilities and communications continued; manufacturing sector rebounded. - Factors explaining manufacturing rebound: Windsor Framework reduced Brexit uncertainty; pent-up investment demand from early COVID; full tax-expensing of business investment in plant and machinery introduced in 2023 Spring budget and made permanent in 2023 Autumn statement. - Sector financing patterns: transport and communications utilized tax incentives (operational cash flows) to finance capital expenditures; manufacturing recovery driven by profits and long-term financing. - Forward-looking constraints: permanent tax incentives support investment but profitability and access to long-term financing crucial for sustained growth. ### Public spending pressures and fiscal outlook (ten-year horizon) - Scenario setup and baseline assumptions - Scenario bottom-up across spending functions; approximately consistent with IMF staff baseline to FY2028/29, which assumes real growth in Departmental Expenditure Limits (DEL) of two percent per year after FY2024/25. - Revenue stabilizes in FY2028/29 at level projected by IMF staff: 40.8 percent of GDP. - Public debt projection: reaches 101.3 percent of GDP by FY2034/35 under scenario (does not stabilize over ten years). - Stabilizing debt requires primary balance to be 0.8–1.4 ppts of GDP higher per year (on average after FY2024/25), depending on time horizon and target probability. - Scenario functional priorities and assumptions - High priority spending: state pension, health, social care, housing, education; defence assumed to reach 2½ percent of GDP per year. - Scenario consistent with increased investment in green transition; may require prioritization over other capital expenditure. - Most other drivers of spending assumed constant in percent of GDP. - Health sector and NHS workforce plan - Acute pressures: NHS vacancy rates elevated; resource adequacy metrics below peers; higher reported disability rates. - NHS Long-Term Workforce Plan - Aim: 27 percent expansion of training places by FY2028–29 for medical personnel. - Measures to reduce attrition include allowing retirees to return to work while accessing pensions. - Workforce growth assumption: NHS workforce would grow by around 2½–3 percent per year. - Numerical staffing projection: increasing total NHS staff numbers from 1.4 million in FY2021–22 to 2.2–2.3 million in FY2036–27. - IFS estimate (2023 Green Budget): annual NHS budget increases of around 3.6 percent per year in real terms (or 70 percent in total by FY2036–37). - Scenario implication: health spending rises by 1¾ ppts of GDP between FY2025/26 and FY2034/35. - Social care, housing, education, and pensions - Social care: Health Foundation estimate: real growth of 3½ percent per year needed to keep up with demand; to expand access assumed in spending scenario: real growth of 4.3 percent per year. - Housing: - Spending cuts historically; scenario assumes annual real growth of 5 percent (2018–23 average) to meet demand. - Research estimate: additional 145,000 social/affordable homes needed per year; total new homes required per year to alleviate need: 380,000; total households in need: 3.9 million over 15 years. - Education: - Education spending to around 4½ percent of GDP in FY2024/25 (from 4 percent in FY2019/20). - Scenario: maintain 4½ percent of GDP until FY2029/30, then decline thereafter as pupil numbers fall. - Demographic projection: 9 percent decline in total primary school student numbers in England by 2028; secondary student numbers begin to decline after 2025. - State Pension and welfare - OBR-based assumption: pensions assumed to rise in line with OBR’s January 2024 projection. - Projected level: state pension spending implied to rise to around 150 billion pounds by FY2027/28. - Drivers: ageing (working age to retired population ratio declines from four-to-one to three-to-one by 2050); State Pension age increase to 67 during 2026–28; Triple Lock assumed. - Fiscal share: State pension spending rises from 4.8 percent of GDP in FY2022/23 to 5.6 percent of GDP by FY2034/35. - Public investment and green transition - CDEL path: capital spending rising by 2 percent per year in real terms from FY2025/26–FY2028/29 then 1½–2 percent per year from FY2029/30–FY2034/35. - Implied CDEL share: rising from around 3½ percent of GDP in FY2024/25 to around 3¾ percent of GDP by FY2034/35. - CCC Balanced Pathway to Net Zero: annual public investment in green transition will need to increase by £5–10 billion by 2030. - Projected CDEL in sterling: rises from £99 billion in FY2024/25 to £122 billion by FY2029/30. - Macro-fiscal aggregates and debt dynamics - Revenue baseline: revenue rises to 40.8 percent of GDP by FY2028/29 (fiscal drag from frozen personal income tax thresholds); assumed unchanged between FY2028/29 and FY2034/35. - Interest payments: rise gradually to 4¼ percent. - Public Sector Net Borrowing (PSNB): declines to approximately 2 percent of GDP by FY2031/32, but falls no further. - Public Sector Net Debt (PSND) (excl. BoE): increases to 101.3 percent of GDP by FY2034/35 (does not stabilize). - Fiscal adjustment required to stabilize debt - Adjustment paths (average annual excess primary balance relative to staff baseline) - Path 1 (50% probability over 5 years): 0.8 ppts. of GDP. - Path 2 (75% probability over 5 years): 1.2 ppts. of GDP. - Path 3 (75% probability over 10 years): 1.4 ppts. of GDP. - Debt level at end of horizon relative to staff baseline: Path 1 = -3.9; Path 2 = -5.9; Path 3 = -11.1. - Impact on level of real GDP by end of horizon: Path 1 = -1.7; Path 2 = -2; Path 3 = -2.1. - Additional annual fiscal adjustment needed because of impact on real GDP: Path 1 = 0.35; Path 2 = 0.4; Path 3 = 0.23. - Fiscal multiplier assumption: impact fiscal multiplier of 0.4 for revenue measures, decaying to 0.3 in t+1 and 0.2 in t+2. - Extended exercise with feedback: allowing additional fiscal effort to reduce real GDP by 1¾–2 ppts per year by FY2029/30 implies required fiscal effort would rise by an additional 0.35–0.4 ppts. of GDP per year approximately to stabilize debt within five years. - Concluding notes - Fiscal effort required to stabilize debt is significant; could combine revenue-raising and spending reform (including indexation of pensions instead of Triple Lock). - Efficiency measures (AI, digitalization) could help but are hard to quantify ex ante. - Debt stabilization more challenging if spending pressures exceed presented scenario. ### Annex II — High Spending Scenario (summary) - Aggregate and fiscal projections - DEL path: DEL (RDEL and CDEL) rising by 3½ percent per year in real terms on average over FY2025/26–FY2034/35; AME grows with population and inflation. - Primary spending rises throughout ten-year horizon, reaching 42.4 percent of GDP by FY2034/35. - PSNB increases to 6½ percent of GDP by FY2034/35. - PSND (ex. BoE) rises to 124.7 percent of GDP by FY2034/35. - To stabilize public debt over ten years, primary balance would need to be higher by around 2.3 ppts. of GDP per year on average. - Key functional differences from central scenario - Education: increase to around 5¼ percent of GDP by FY2029/30 (pre-GFC funding level). - Social Care: real growth of 6 percent p/a (vs central 4.3 percent p/a). - Housing: spending on affordable housing rises by 11 percent real growth p/a until FY2029/30. - Environmental Protection: increase to 0.6 percent of GDP (2000–10 avge). - Public Order & Safety: grow by 3.8 percent real p/a. - Interest payments and projections: consistent with evolution of primary spending and debt using IMF’s Debt Sustainability Analysis Tools. ### Construction planning system — constraints, evidence, and reform directions - Characterization of current system - UK construction planning described as overly stringent, localized, discretionary, and unpredictable, inhibiting new residential, commercial, and infrastructure projects. - Local decision-making often prioritizes short-term local issues and can ignore wider regional and national externalities. - Quantified impacts and literature findings - Planning permissions can increase development costs by up to 10 percent. - Since 1945, almost 4.3 million fewer houses were built due to planning restrictions (close to a fifth of the housing stock). - Hilber & Vermeulen (2016) estimate without regulatory constraints prices would have been 35 percent lower in the 2000s. - UK has seen no increase in built-up land per capita since 1990, unlike other G7 economies. - Home ownership by age 34 fell from 70 percent in 1950s to less than 34 percent today. - Economic consequences - Stringent planning contributed to depressed UK business investment (share of GDP) relative to 2000s and loss of investment to peers (data centers, life sciences). - Planning restrictions create barriers for net zero infrastructure (onshore wind, solar, grid connections). - NIC estimate: easing planning constraints in Milton Keynes-Cambridge arc could double contribution to UK growth by 2050 and triple local job creation. - International comparisons and successful reforms - Germany, France, Netherlands: more rule-based, centralized/regional decision-making. - Israel: community/developer collaboration on neighborhood renewal with incentives. - Houston, Texas: regulations empowering landowners to densify properties, "gentle density" associated with lower house prices. - New Zealand (Auckland, 2016): upzoned ~three quarters of residential land into three zones allowing greater density; resulted in construction boom and prevented large price/rent rises elsewhere. - Policy recommendations and politically feasible reforms - Reduce discretionary decision-making for permissions; adopt broader geographic and rules-based decision-making for business and large residential developments. - Digitalize and standardize local plans; make them binding for designated growth areas. - Careful release of Green Belt land with "minimal environmental or amenity value" near stations with easy access to major cities; use development charges to fund rail, social housing, infrastructure, and local services; consider Green Development Corporations (GDCs). - Targeted incentives and resources for local authorities: financial grants, technical assistance, capacity building, linking funding to planning performance. - Tax measures: lower Stamp Duty for residential and non-residential properties; council tax reform aiming for "at least revenue neutrality" to reduce moving costs and spur mobility. - Additional measures: objection thresholds, incentives for compliant projects, penalties for delays, and community-driven approaches to align resident and developer interests. - Croydon case study - 2018 planning guidance allowed homeowners to convert single-family homes into apartments, boosting supply and affordability versus rest of London. - Croydon SPD2 adopted April 2019 and revoked June 2022: small-scale densification produced supply gains but repeal highlighted political risk and need for ex-ante community communication. - Implementation constraints - Stop-start national reforms and political opposition have diluted earlier proposals (2020 Planning for the Future White Paper revisions). - Local capacity shortages and skills gaps (e.g., environmental/safety professionals) require resources and training to implement reforms. ### Skills gaps, education, and workforce development - Extent and measurable gaps - 15 percent of employers report at least one member of staff not fully proficient (up from around 13 percent in 2017). - Density of skills gap increased from 4.4 percent in 2017 to 5.2 percent in 2022. - 5.2 percent in 2022 equivalent to 1.72 million employees (2017: 1.27 million). - Nearly a third of companies reported lack of availability of skilled labor limited firm output. - Smaller firms (2 to 4 employees) more likely to report major impact from skills gaps. - Sectoral patterns and international mismatch indicators - Field-of-study mismatch (UK): almost 40 percent (2019); OECD average: 31.7 (2019). - Underqualification in the UK: 40.5 percent; OECD average: 34.4 percent. - Learning and Work Institute estimate: skills shortage will cost £120 billion by 2030, with shortfall of 2.5 million highly skilled workers and oversupply of more than 8 million people with low skills. - Drivers of shortages - Weakening educational outcomes, declines in adult education, Brexit and COVID shocks, population aging. - Employer investment in skills per employee declined 19 percent (real terms) between 2011 and 2022; larger businesses: -35 percent; primary sector: -44 percent; public sectors: -38 percent. - Migration patterns post-Brexit have not fully offset EU-worker losses; small firms face hiring hurdles for non-EU workers. - Primary, secondary, and tertiary education financing and outcomes - Public spending on primary to post-secondary institutions: 3.7 percent in 2020 (OECD average: 3.3 percent). - IFS estimate: 9 percent real terms fall in spending per student from 2010 to 2020. - PISA performance: UK mean performances in reading, mathematics, and science declined over two decades and notably from 2018 to 2022. - Tertiary financing shifts: UK public spending on tertiary institutions halved from 1 percent of GDP in 2012 to 0.5 percent in 2020; private spending increased from 0.7 to 1.5 percent of GDP between 2012 and 2020. - Tuition fees from non-UK students in 2021–22: 42 percent of higher education course fees; 21 percent of all income for universities in England. - STEM and vocational education - Share of UK graduates from STEM courses: 26 percent. - A-level STEM entries: 258,790 in 2019; 276,641 in 2023. - Vocational upper secondary graduates in in-demand sectors (UK): 7.9 percent; OECD average: 31.8. - Student-to-teacher ratio in vocational programs (UK): 24.7 to 1; OECD average: 15 to 1. - Apprenticeships: high level apprenticeships tripled since 2017; apprenticeship starts for ages under 24 almost halved after the pandemic. - Tertiary students, visas, and labor market integration - Graduate Visa Scheme permits students to stay 2 years post-graduation to job search. - Tuition-fee reliance makes tertiary finances volatile and exposed to immigration policy and visa changes. - Postgraduates now restricted from bringing families; some employers cancelled offers after skilled visa threshold raised from £26,200 to £38,700 in 2024. - Projections of job demand (2020–2035) - Science, research, engineering, and technology professionals: 1.9 million jobs to be filled. - Business, media, and public service professionals: 1.8 million. - Caring personal service occupations: 1.7 million. - Administrative occupations: 1.6 million. - Health and social care associate professionals: 1.2 million. - Qualification-shift projections: 3.5 million fewer jobs needing qualifications below A-level; 6 million more jobs needing higher education qualifications. - Policy recommendations - Primary and secondary education reforms with emphasis on STEM; set ambitious targets to reverse decline in STEM outcomes. - Expand and improve vocational training and apprenticeships; increase vocational graduates in key areas and improve student-to-teacher ratios. - Keep a stable student visa regime and encourage high-skilled students with in-demand skills to remain in the UK. - Continue focus on lifelong learning and on-the-job learning; build on lifelong learning entitlement from 2025 (loans equivalent to four years’ higher education). - Simplify worker visa regime to facilitate hiring by smaller employers who previously relied on EU labour pre-Brexit. *Source: IMF staff summary and analysis excerpted from content unit 1gbrea2024002.* ### 1. Policy Rates, Inflation, and Inflation Expectations ____________________________________ 4 ### 1. Policy Rates, Inflation, and Inflation Expectations ### A. Overview of the current tightening cycle and recent developments - The Bank of England (BoE) raised interest rates 14 consecutive times between December 2021 and August 2023. - Bank Rate reached a peak of 5.25 percent in August 2023 and has been held at 5.25 percent since then. - The current tightening cycle is the BoE’s most aggressive since independence in 1997 and, as of May 2024, lasts 30 months (starting from December 2021). - The cumulative increase in Bank Rate over the current cycle is 5.15 ppt. - Headline inflation: - Peaked at around 10–11 percent in late 2022/early 2023. - Fell to 2.3 percent in April 2024. - Is expected to durably return to the 2 percent target in early 2025. - Market-implied 5-year ahead inflation expectations (adjusted for the RPI–CPI wedge) are around 2.5 percent. - Long-run inflation expectations have been well-anchored throughout the tightening cycle. - Real rates only became comparable with previous cycles in Spring 2023 due to record-high inflation earlier in the episode. ### B. Comparison with previous UK tightening cycles (Table 1) - Summary of tightening-cycle metrics: - 1999-Sep to 2001-Jan: Duration 17 months; Total Rate increases 1 ppt; # of Rate Hikes 4; Inflation (highest) 1.3%; Inflation (lowest) 0.6%. - 2003-Nov to 2005-Jul: Duration 21 months; Total Rate increases 1.25 ppt; # of Rate Hikes 5; Inflation (highest) 2.4%; Inflation (lowest) 1.1%. - 2006-Aug to 2007-Nov: Duration 16 months; Total Rate increases 1.25 ppt; # of Rate Hikes 5; Inflation (highest) 3.2%; Inflation (lowest) 1.7%. - 2017-Nov to 2020-Feb**: Duration 28 months; Total Rate increases 0.5 ppt; # of Rate Hikes 2; Inflation (highest) 3.2%; Inflation (lowest) 1.3%. - 2021-Dec to present***: Duration 30 months; Total Rate increases 5.15 ppt; # of Rate Hikes 14; Inflation (highest) 11.1%; Inflation (lowest) 2.3%. - Notes: - The length of a tightening cycle is measured as the number of months from the first rate hike to the last month before the first rate cut. - The 2017-Nov to 2020-Feb cycle is excluded from some comparisons due to relatively small rate hikes but a long holding period. - The current cycle’s scale of tightening is commensurate with the unprecedented size of the inflation shock. ### C. Macroeconomic and sectoral effects observed so far - Real GDP growth has been much weaker than in all previous cycles, reflecting: - Supply constraints (pandemic-related global supply disruptions). - Terms-of-trade shock from the energy price surge related to Russia’s war in Ukraine. - Labor shortages. - Domestic demand dynamics: - Household consumption weakened substantially and is a major contributor to weak GDP growth due to high cost of living and weak consumer confidence. - Investment has held up better in recent years, including public investment, despite a prior extended period of weak investment. - Monetary transmission has largely mirrored previous episodes and experiences in other major advanced economies, with a notable exception: - The mortgage channel has been slower due to a higher share of fixed-rate mortgages. ### D. External spillovers, communication, and policy-path implications - U.S. Federal Reserve (Fed) announcements have an outsized impact on UK financial markets. - This heightened sensitivity implies a premium on BoE communications, particularly when the BoE may diverge from the Fed. - Model-based predictions of optimal UK rate paths (which seek to stabilize inflation and the output gap) are close to staff’s recommended path in the 2024 Article IV consultation. - If the BoE placed a high weight on the risk of a prolonged period of above-target inflation leading to de-anchoring of inflation expectations, model results indicate a slower pace of cuts would be warranted. *Source: IMF staff summary (June 14, 2024) — “Policy Rates, Inflation, and Inflation Expectations.”* ### Annex I on micro underpinnings of the weaker consumption and stronger investment responses). ### Annex I — Micro underpinnings of the weaker consumption and stronger investment responses ### Monetary transmission: overview and key channels - Monetary transmission in the UK during the current cycle has mostly worked as expected and has been similar to the experiences in other AEs. - Staff’s preferred Financial Conditions Index (FCI) showed an initial impact somewhat stronger than previous cycles but has eased recently. The impact on FCI and other market indicators is adjusted for the size of total rate hikes (measured as the elasticity of FCI to the cumulative rate increases). - Three FCI components highlighted: - Interest rate channel - Response of “new” bank lending rates (including corporate and household loans) is similar to previous cycles. - “Effective” rates on corporate loans and household non-mortgage loans are consistent with previous cycles. - Increase in “effective mortgage rates” significantly undershot previous cycles due to a higher share of fixed-rate mortgages; passthrough of corporate bond yields settled at around 0.7. - Gilt yields have been more responsive to policy rate increases than previous cycles, potentially reflecting concerns about public finances after the September 2022 “mini-budget” episode. - Asset price channel - Equity prices (FTSE100) have held up relatively well. - House prices have been more subdued in the current cycle — a potential contributor to weaker household consumption via wealth effects. - Credit channel - Bank lending has almost remained flat in the current cycle, a clear break from the past. - Weakness of bank lending may reflect monetary tightening, structural post-GFC changes, and increased borrowing during COVID under government-backed schemes. - Corporate capital issuance through markets has been volatile but not significantly different from previous cycles. ### Macro outcomes and cross-country comparison - GDP growth has been notably weak compared with previous tightening cycles, largely reflecting weak consumption, while investment has shown some resilience (supply constraints have also played an outsized role). - Controlling for the size of monetary tightening, the UK’s weak GDP and consumption response seem comparable to other countries, while stronger investment stands out. - Fiscal deficits have been relatively larger than in peer countries, reflecting somewhat stronger COVID support by UK authorities. - Wage growth similar to peers but seems more persistent, likely due to a tighter labor market. - Real effective exchange rate: initially depreciated and has appreciated in recent quarters, mainly driven by interest rate differentials with the US. ### FOMC spillovers, MPC timing, and market examples - The FOMC’s monetary policy decisions often have a nontrivial impact on UK financial markets and can affect UK domestic demand through these market channels. - Example: December 13–14, 2023 - FOMC signaled potential 75bps rate cuts in 2024 on December 13, 2023 (after UK markets closed). - On December 14, the 2-year gilt yield dropped 20 bps within 15 mins after the market opened. - Later that day the BoE MPC announced a hawkish hold (three out of nine members voting for a further rate hike) with no press conference; after the MPC decision, markets scaled back rate-cut expectations slightly but still expected more than 100bps of rate cuts in 2024 (up from 75 bps the day before). - The 2-year gilt yield increased 3 bps within 30 minutes around the MPC's announcement. - MPC meeting procedure and timing - MPC generally meets several times before each announcement; final meeting held Wednesday of the announcement week; decision published Thursday at noon with minutes and, every quarter, a Monetary Policy Report (MPR) accompanied by a press conference led by the Governor. - In 2023 and 2024, there are five MPC meetings each year, with decisions announced one day after the FOMC's decisions, and three of them did/do not have press conferences. - Historical sample of back-to-back meetings - Identified 41 FOMC announcements that occurred one day before MPC announcements from 1999 to mid-2023. - Many back-to-back meetings occurred after 2016 when MPC switched to eight decisions a year. ### Identification of shocks, factor structure, and empirical approach - High-frequency market movements around policy announcements are used to identify monetary policy surprises (reference methodology: Gurkaynak et al. 2005; Swanson 2021; Braun et al. 2023). - Data sources and sample windows - UK Monetary Policy Event-Study Database (UKMPD) for intraday UK monetary surprises since 1997. - For regression/event windows around FOMC announcements (US Eastern Time), differences between opening prices next day and closing prices on FOMC announcement day are used to proxy UK market reactions. - Monthly data period for LP-IV analysis: 1997 June to 2019 December. - Factor analysis: three MPC factors and two FOMC spillover factors - MPC factors: Target (highest loading with short-term rates — policy rate news), Path (highest loading with 4-quarter ahead sterling future — forward guidance), QE (highest loading with 10-year gilt — unconventional policy). - FOMC spillover factors: Spillover 1 (impact on short-term interest rates), Spillover 2 (impact on medium- to long-term interest rates). - Correlations show MPC factors and FOMC spillovers can occasionally produce opposing shocks on the same day; FOMC announcements can have sizable impacts on short-term rates (Spillover 1) and smaller impacts on medium- to long-term rates. ### Regression evidence on market effects of FOMC spillovers - Simple regression setup: ∆Y_t = α + β Spillover1_t + γ Spillover2_t + ε_t, where ∆Y_t denotes change in relevant asset price. - Key regression findings (N = 41 observations): - Spillover 2 is associated with a slight depreciation of sterling against the dollar (USD/GBP coefficient: -0.082***; R2 = 0.124; N = 41). - Spillover 1 coefficients show mixed, generally insignificant estimates for equity indices and exchange rates in Table 2. - Notes: GBP/EUR is the value of British pound per euro (an increase indicates sterling depreciation); USD/GBP is the value of US dollar per British pound (an increase indicates sterling appreciation). Standard errors reported in parentheses; significance: * p<0.1, ** p<0.05, *** p<0.01. - Interpretation: FOMC announcements (via forward guidance) can push up long ends of US and UK yield curves, widen interest rate differentials, and lead to sterling depreciation versus the dollar; limited impact on UK stock markets or GBP/EUR bilateral rate. ### Macro effects of MPC shocks and role of FOMC spillovers (LP-IV results) - Estimation approach: Stock and Watson (2018) local projections with external instruments (LP-IV). Instruments include three MPC shocks (Target, Path, QE) and, in extended specifications, two FOMC shocks (Spillover 1 and 2). Control variables include 12 lags of dependent variables and external instruments. - Baseline impulse response to a 100-bps increase in Bank Rate (Target shock): - A 100-bps monetary policy tightening through Bank Rate leads to about 1.2 percentage points decline in real GDP within 30 months. - The effect is persistent and remains at about 1-1.2 percentage points 36 months after the shock. - Confidence bands shown: 68 percent and 90 percent. - Including FOMC spillovers: - FOMC spillovers strengthen monetary transmission of Bank Rate by pushing forward the GDP impact; peak impact reaches about six months earlier compared with baseline without FOMC shocks. - Caveats and data limitations: - Very few observations since 2021 prevent limiting analysis to the current cycle. - High volatility of macro and financial indicators during COVID introduced additional noise to the analysis. - The current cycle exhibits some abnormality (e.g., December 14, 2023) where market reactions to FOMC and MPC decisions were inconsistent; in such instances, FOMC spillovers can work against MPC objectives. ### Policy communication and operational recommendations for the MPC - Key takeaway: The current approach — MPC makes its decision before the FOMC decision is announced but announces its decision after markets have absorbed the Fed decision — may be suboptimal because MPC decisions and communications do not consider the Fed’s immediate impact on domestic financial conditions. - Recommended adjustments to improve effective MPC communications: - Consider streamlining the amount of information published alongside the MPC decision to enable the MPC decision to be announced on the same day (rather than delaying the decision announcement to allow the MPR/minutes to accompany it). - Consider delaying publication of MPC minutes and the MPR by about a week (analogous to FOMC practice). - Consider holding a press conference after each MPC decision (as done by other major central banks) to provide opportunity to elaborate or caveat views when market reactions to FOMC decisions are inconsistent with the MPC’s intended direction. ### Model-based alternative monetary policy paths (COPP toolkit and optimality) - Toolkit and model - The staff use the Constrained Optimal Policy Projection (COPP) toolkit (De Groot et al. (2021)) with a Svensson (2000) semi-structural open economy model (Philips curve, IS curve, UIP). - Model calibrated to match estimated transmission from VARs for advanced economies (impulse responses to a 100bps monetary policy shock shown in Figure 7). - Optimality objective and loss function - Quadratic loss function: - L = E_t Σ_{t=0}^∞ [ λ_π (π_t − π^*)^2 + λ_y (y_t − y^*)^2 + λ_i (i_t − i_{t-1})^2 ] - Weights examined (Table 3): - Weights and loss function results (Loss Function relative to staff projection) - Baseline Loss Function: λ_π = 1, λ_y = 1, λ_i = 1, Loss Function (relative to staff projection) = 0.53 - High Inflation Weight: λ_π = 5, λ_y = 1, λ_i = 1, Loss Function (relative to staff projection) = 0.66 - High Output Weight: λ_π = 1, λ_y = 5, λ_i = 1, Loss Function (relative to staff projection) = 0.54 - High Interest Rate Weight: λ_π = 1, λ_y = 1, λ_i = 5, Loss Function (relative to staff projection) = 0.56 - Benchmarks and simple rules - Two simple policy rules computed for comparison: - Taylor Rule I: coefficient of 0.9 on lagged Bank Rate (S), 1.5 on annual CPI inflation (π), 1 on output gap (y). - Taylor Rule II: coefficient of 0.75 on lagged Bank Rate, 2 on annual CPI inflation. - These serve as points of comparison against the optimal policy projection and the staff’s baseline projection. *Source: IMF staff Annex I (micro underpinnings of the weaker consumption and stronger investment responses).* ### 0.5 on output gap. Taylor rules take the form: 푆푆 ### 1gbrea2024002 - 0.5 on output gap. Taylor rules take the form: 푆푆 ### Optimal policy projections and comparison with staff baseline - Staff’s baseline policy projection is close to optimal, but differs in the timing of rate cuts. - The optimal interest rate policy: - Suggests a much earlier reduction in the policy rate, followed by a period of rates at around 4 percent in 2025-6. - Brings forward the date at which the projected output gap is closed, taking transmission lags into account. - The broad pattern of policy moves is not particularly sensitive to the weight placed on different objectives in the loss function. - Under all different assumptions of the loss function, inflation converges to the 2 percent target by 2025. - Figure references: Figure 9 shows closeness of optimal paths to baseline; Figure 9 note: "The baseline projection (blue solid line) is from the 2024 Article IV staff report." ### De-anchoring risk and constrained optimal policy - Baseline simulations assume perfect foresight and always-anchored inflation expectations (benchmark). - To capture de-anchoring risk, assumption: only a fraction a=0.5 of agents have perfect foresight with inflation expectations staying at the target, and that fraction decays at the exponential rate for each quarter of the projection horizon. - Under de-anchoring risk: - The constrained optimal policy path moves closer to the staff’s baseline projection (more gradual normalization). - Nevertheless, given a still negative output gap, there remains an incentive to normalize the interest rate path quicker than in the baseline projection to stimulate output. - Figure references: Figure 10 shows constrained optimal projections under de-anchoring risk; Figure 10 note: "The baseline projection (blue solid line) is from the 2024 Article IV staff report." ### Targeting core inflation: sensitivity analysis - If the BoE targets core inflation (a measure closer to domestically-generated inflation), core inflation displays a higher degree of inertia relative to headline inflation. - This higher inertia increases the trade-off between inflation and output stabilization. - Despite the more pronounced trade-off, the constrained optimal policy path remains similar to the baseline case of targeting headline inflation. - Conclusion: the "cut, hold, cut" prescription is robust to assuming a higher degree of inflation inertia. - Figure references: Figure 11 shows constrained optimal policy projections of core inflation; Figure 11 note: "The baseline projection (blue solid line) is from the 2024 Article IV staff report." ### Micro underpinnings — consumption dynamics - Weak household consumption appears driven by the high cost of living and weak consumer confidence. - Findings from Bank of England/NMG household survey: - From 2019 to 2022: - General increase in median consumption across all income groups, largely due to higher costs of living. - Higher consumption financed largely by withdrawal of savings or by more borrowing (more likely for the lower income group). - From 2022 to 2023: - Across-the-board increases in household income, but these were largely saved — likely due to weak consumer sentiment. - Mortgage channel and monetary transmission: - Less than 30 percent of households in the survey have mortgages. - About 50 percent of households in the highest income group have mortgages; less than 10 percent in the lowest income group. - Distribution of mortgages subject to repricing each year follows a similar pattern. - Larger increases in mortgage payments observed in lower income groups in 2022 (Group 1) and 2023 (Group 2) were likely due to other factors (such as new mortgages) rather than repricing of existing mortgages. - Near-term outlook: despite continued flows of fixed-rate mortgages being subject to higher rates, this is not expected to be a major drag on consumption; continued strong wage growth and improving consumer sentiment will likely support a consumption recovery. ### Micro underpinnings — investment dynamics - Business investment is picking up after a long period of stagnation. - Firm-level Worldscope data (asset-weighted) findings: - Utilities and communications sectors had the highest increases in capital expenditures from 2019 to 2022; manufactures declined over that period. - From 2022 to 2023: - Strong investment in utilities and communications continued. - Manufacturing sector rebounded. - Factors explaining manufacturing rebound: - The Windsor Framework agreement reduced Brexit-related uncertainty. - Pent-up investment demand built up during early COVID period. - Full tax-expensing of business investment in plant and machinery introduced in the 2023 Spring budget and made permanent in the 2023 Autumn statement. - Not all sectors utilized tax incentives equally: - Transport and communications appear to have utilized tax incentives (shown as other operational cash flows) to finance capital expenditures. - Representative manufacturing firms show recovery of profits (net income from operation) as main driver of 2023 capital expenditure recovery; long-term financing (including equity) also helped. - Forward-looking constraints: - Permanent tax incentives will support business investment, but positive outlook (profitability) and access to long-term financing are crucial for sustained investment growth. ### Public spending pressures and fiscal outlook (ten-year horizon) - Project scope: - Characterizes UK public spending pressures over a ten-year horizon and implications for public deficits and debt. - Scenario built bottom-up across spending functions; approximately consistent with IMF staff’s baseline to FY2029/30, which assumes real growth in Departmental Expenditure Limits (DEL) of two percent per year after FY2024/25. - Key fiscal numbers and projections: - Assuming revenue stabilizes in FY2028/29 at the level projected by IMF staff (40.8 percent of GDP), public debt reaches 101.3 percent of GDP by FY2034/35 (i.e., does not stabilize over ten years). - Stabilizing debt would require the primary balance to be 0.8–1.4 ppts of GDP higher per year (on average after FY2024/25), depending on the time horizon for stabilization (5 or 10 years) and the target probability of debt stabilization (50 or 75 percent). - Scenario assumptions and priorities: - Scenario approximately consistent with IMF staff medium-term baseline (2024 Article IV Staff Report): spending rises by 2 percent per year in real terms (RDEL and CDEL) until FY2028/29; non-interest AME rises with population growth and inflation on average. - Scenario encapsulates high priority spending: state pension, health, social care, housing, education; defence spending assumed to reach 2½ percent of GDP per year. - Scenario consistent with increased investment in the green transition; may require prioritization over other capital expenditure. - Projections assume most other drivers of spending remain constant in percent of GDP; detailed functional assumptions presented in Text Table 1 and implied levels in Text Tables 2–3 (figures referenced in source). ### Health sector pressures and NHS workforce plan - Acute pressures: NHS staff vacancy rates elevated; resource adequacy metrics (hospital beds, doctors, nurses per capita) below peer countries; higher reported disability rates suggest additional strain. - NHS Long-Term Workforce Plan (to address shortages): - Aim: 27 percent expansion of training places by FY2028–29 for medical personnel, including doctors and nurses. - Measures to reduce attrition include allowing retirees to return to work while still accessing pensions. - Workforce growth assumption: NHS workforce would grow by around 2½–3 percent per year. - Numerical staffing projection: increasing total NHS staff numbers from 1.4 million in FY2021–22 to 2.2–2.3 million in FY2036–27. *Source: IMF staff calculations.* ### 10. In its 2023 Green Budget, the Institute of Fiscal Studies (IFS) estimates that annual ### 10. In its 2023 Green Budget, the Institute of Fiscal Studies (IFS) estimates that annual NHS budget increases of around 3.6 percent per year in real terms (or 70 percent in total by FY2036–37), in line with the long-run average real-terms growth rate in UK health spending ### Health - IFS estimate: annual NHS budget increases of around 3.6 percent per year in real terms (or 70 percent in total by FY2036–37). - Historical context: 3.6 percent per year from FY1949–50 to FY2022–23; 2.4 percent since 2009. - Staffing/productivity assumption: sufficient to fund the Long-Term Workforce Plan under the ambitious assumption that annual labor force productivity in the health system would grow by 1½–2 percent. - Fiscal implication in scenario: health spending rises by 1¾ ppts points of GDP between FY2025/26 and FY2034/35 (assumed in the spending scenario). ### Social Care - Delivery: provided by local governments and is means tested (contrast to universal NHS). - Health Foundation estimate (September 2023): real growth of 3½ percent per year over the next decade needed to keep up with demand. - To expand access (as assumed in the spending scenario): real growth of 4.3 percent per year. ### Housing - Historical cuts: spending on housing and communities cut by 32 percent in real terms between FY2010/11 and FY2015/16; spending in FY2022/23 was 1.7 percent above the FY2010/11 level in real terms. - Need estimates: Research commissioned by the National Housing Federation (2019) estimated an additional 145,000 social / affordable homes are needed per year; estimated total new homes required per year to alleviate need: 380,000; total households in need: 3.9 million over 15 years. - Spending scenario assumption: annual real growth of 5 percent (2018–23 average) to meet demand, though the precise amount is uncertain. - Historical growth: spending on housing grew by an average annual amount of 11 percent in real terms during 2000-2010. ### Education - Recent changes: increases in schools funding set to boost overall education spending to around 4½ percent of GDP in FY2024/25, from 4 percent of GDP in FY2019/20. - Rationale: prior gradual decline in funding per pupil in secondary and further/vocational education between FY2010/11 and FY2019/20; sharper decline in higher education funding per pupil. - Scenario assumption: education spending remains at 4½ percent of GDP per year until FY2029/30, then declines thereafter as ageing implies declining pupil numbers. - Demographic projections: a 9 percent decline in total primary school student numbers is expected in England by 2028; absolute numbers of secondary school students expected to begin to decline after 2025 (UK Department for Education’s 2023 projections). - Composition: primary and secondary schooling account for around 80 percent of education spending. - Note: well-reported capital spending needs for schools. ### Uprating of State Pension and Other Welfare Benefits (e.g., Universal Credit) - OBR-based assumption: pensions assumed to rise in the spending scenario in line with the OBR’s January 2024 projection for state pension spending. - Projected level: state pension spending implied to rise to around 150 billion pounds by FY2027/28. - Drivers accounted for: - Ageing: ratio of the working age to retired population to decline from four-to-one to three-to-one by 2050 (despite higher migration; steady state net migration assumed at 245,000). - State Pension age increase: increase to 67 during 2026–28 (partly offsetting effect on beneficiaries). - Triple Lock: pension spending set to grow by the rate of average wage growth, assumed to exceed both inflation and the floor of 2.5 percent. - Fiscal share: State pension spending rises from 4.8 percent of GDP in FY2022/23 to 5.6 percent of GDP by FY2034/35. ### Public Investment and the Green Transition - CDEL path (scenario): capital spending (CDEL) rising by 2 percent per year in real terms from FY2025/26–FY2028/29 (as in staff’s baseline) then to grow by 1½–2 percent per year in real terms from FY2029/30–FY2034/35. - Implied CDEL share: CDEL rising from around 3½ percent of GDP in FY2024/25 to around 3¾ percent of GDP by FY2034/35. - Climate/green transition: - CCC Balanced Pathway to Net Zero implies annual public investment in the green transition will need to increase by £5–10 billion by 2030. - Projected CDEL in sterling: rises from £99 billion in FY2024/25 to £122 billion by FY2029/30 (this path could accommodate the £5–10 billion increase). - Departments involved: Departments of Energy Security and Net Zero; Departments of Environment, Food and Rural Affairs (spending spread across several departments). - Transport: - Recent increase: transport spending to 2 percent of GDP in FY2024/25. - Scenario assumption: maintain 2 percent of GDP to FY2029/30, before a gradual decline; incorporates both RDEL and CDEL. - Health and education capital: rise of CDEL could accommodate increased capital spending on health and education facilities; precise amount uncertain. - Prioritization: outside key areas, prioritization would be necessary in the spending scenario. ### Other Drivers - Defence: budgeted at 2–2½ percent of GDP in FY2024/25 (budget data); assumed to rise to 2½ percent of GDP (in line with government commitments). - General Public Services (including external affairs): currently around 2¼ percent of GDP; assumed to decline gradually after FY2029/30 back to FY2010–19 average of 0.6 percent of GDP assuming the Ukraine emergency is resolved. - Public Order & Safety, Economic Affairs, Recreation/Culture/Religion: scenario notes to maintain or return to historical averages in percent of GDP as indicated in the assumptions table. ### Scenario Assumptions (Table summary) - Aggregate spending: - RDEL real growth of 2 percent p/a to FY2029/30 then 1½–2 percent p/a. - CDEL 2 percent p/a real growth to FY2029/30 then 1½–2 percent p/a. - AME rises with population growth and inflation on average over time. - Functional expenditure assumptions—selected: - Health: Real growth of 3½ percent p/a all years to fund NHS workforce plan. - Education: Maintain at 4½ percent GDP until FY2029/30, then decline to 4 percent GDP as student numbers fall. - State Pension: Increase in line with OBR 2023 MT estimates, adjusted for 1yr rise of retirement age FY2026/27. - Social Care: Real growth of 4.3 percent p/a all years to meet demand & improve access (Health Foundation est.). - Housing and Community Amenities: 5 percent real growth (2018–23 avge) p/a to meet demand; constant in percent of GDP after FY2029/30. - Transport: Maintain at 2 percent GDP until FY2029/30, then at FY2028–23 average of 1.8 percent GDP. - Environmental Protection: Maintain current percent GDP (0.4-0.5). - Defence: 2½ percent GDP per year. - Interest payments: projected interest payments are consistent with evolution of primary spending and debt in each scenario (computed using IMF’s Debt Sustainability Analysis Tools). ### Macro-Fiscal Implications - Revenue baseline: IMF staff’s baseline revenue projection implies revenue rises to 40.8 percent of GDP by FY2028/29 (due to fiscal drag associated with frozen personal income tax thresholds); revenue projected to remain unchanged at this level (in percent of GDP) between FY2028/29 and FY2034/35 for the scenario. - Primary expenditure dynamics: declines over the ten-year projection horizon, consistent with AME spending declining as a share of GDP (AME is 60 percent of total spending, including non-pension welfare). - Growth assumptions: AME grows approximately in line with population growth and projected inflation; population growth assumed to follow ONS January 2023 projections until FY2028/29; inflation returns to two percent inflation target from FY2025/26 and remains thereafter. - Interest payments: rise gradually to 4¼ percent. - PSNB and PSND implications: - Public Sector Net Borrowing (PSNB) declines to approximately 2 percent of GDP by FY2031/32, but falls no further. - Public Sector Net Debt (PSND) (excl. BoE) does not stabilize and increases to 101.3 percent of GDP by FY2034/35. - Method for debt projection: primary balance and interest payments combined with revenue projection; PSND projected using stock flow adjustments implied by the OBR’s 2024 Spring Budget projections until FY2028/29 and then assuming annual stock flow adjustments remain unchanged as a share of GDP thereafter until FY2034/35. ### Fiscal Adjustment to Stabilize Debt - Additional fiscal effort required: could involve a combination of revenue-raising measures and spending reform (including indexation of pensions to the cost of living instead of the Triple Lock). - Efficiency measures: credible efficiency-increasing measures could be considered (e.g., harnessing AI and digitalization in service delivery and administration). - Modeling approach: additional fiscal effort modeled as higher revenue, via a uniform increase in the elasticity of nominal revenue to GDP growth over the stabilization horizon (combination of unspecified revenue measures). Calculation is partial equilibrium (impact of effort on growth, inflation, interest/exchange rates assumed zero, except in extended exercise below). - Adjustment paths (Text Table 4 / Table 4): - Path 1 (50% probability over 5 years): average annual excess public sector primary balance relative to staff’s baseline = 0.8 ppts. of GDP. - Path 2 (75% probability over 5 years): average annual excess public sector primary balance = 1.2 ppts. of GDP. - Path 3 (75% probability over 10 years): average annual excess public sector primary balance = 1.4 ppts. of GDP. - Debt level at end of horizon relative to staff’s baseline: Path 1 = -3.9; Path 2 = -5.9; Path 3 = -11.1. - Impact of adjustment on level of real GDP by end of horizon: Path 1 = -1.7; Path 2 = -2; Path 3 = -2.1. - Additional annual fiscal adjustment needed because of impact on real GDP: Path 1 = 0.35; Path 2 = 0.4; Path 3 = 0.23. - Note: fiscal multiplier assumption underlying GDP impacts: based on an impact fiscal multiplier of 0.4 for revenue measures, which decays to 0.3 in t+1 and 0.2 in t+2. - Extended exercise with feedback: allowing additional fiscal effort to reduce real GDP by 1¾–2 ppts per year by FY2029/30 (depending on stabilization probability) implies that incorporating the effect of lower output on revenues and the GDP denominator would raise required fiscal effort by an additional 0.35–0.4 ppts. of GDP per year approximately to stabilize debt within five years. ### Concluding Notes on Fiscal Adjustment - The amount of fiscal effort required to stabilize debt is significant across adjustment paths. - Adjustment could be achieved via higher revenue or reduced spending (percent of GDP); requires difficult choices about taxation and spending priorities. - Productivity improvements in the public sector could yield savings but are difficult to quantify ex ante. - Debt stabilization would be more challenging if spending pressures are more acute than presented; a higher spending scenario is considered as an upper bound (see Annex Two reference). ### Annex II: A High Spending Scenario (summary) - Overall DEL path: DEL (both RDEL and CDEL) rising by 3½ percent per year in real terms on average over FY2025/26–FY2034/35; AME growing by the rate of population growth and inflation on average. - Health: as in central scenario, health grows in line with IFS cost estimates for NHS Long-Term Workforce Plan; Triple Lock maintained. - Key differences from central scenario: - Education: maintain 4½ percent of GDP then increase to around 5¼ percent of GDP by FY2029/30 (pre-GFC funding level). - Social Care: funding increases by 6 percent per year in real terms (Health Foundation amount to keep up with demand and cover all out-of-pocket costs). - Public Order and Safety: grow by the 2000-2010 real growth rate of 3.8 percent, increasing spending from 1.6 percent of GDP currently to 2 percent of GDP by FY2034/35. - Housing: spending on affordable housing rises by 11 percent per year in real terms until FY2029/30 (2000–10 average) to address housing crisis and increase public housing supply. - Environmental Protection: spending increases to accommodate higher green-transition spending than in CCC Balanced Pathway to Net Zero (scenario truncates at this point in source). *Source: 1gbrea2024002 — IMF (content unit provided).* ### 0.6 percent of GDP per year (the 2000–10 average). ### 1gbrea2024002 - 0.6 percent of GDP per year (the 2000–10 average). ### High-Spending Scenario: Fiscal Projections and Debt Dynamics - Primary spending rises throughout the ten-year horizon, reaching 42.4 percent of GDP by FY2034/35. - Public Sector Net Borrowing (PSNB) increases to 6½ percent of GDP by FY2034/35. - Public Sector Net Debt (PSND) (ex. BoE) rises to 124.7 percent of GDP by FY2034/35. - To stabilize public debt over a ten-year horizon, the primary balance would need to be higher by around 2.3 ppts. of GDP per year on average. - Interest Payments are projected consistent with the evolution of primary spending and debt in each scenario, computed using the IMF’s Debt Sustainability Analysis Tools. ### Scenario Assumptions: Aggregate and Functional Spending (FY2025/26 – FY2034/35) - Aggregate spending: - Central Scenario: - RDEL real growth of 2 percent p/a to FY2029/30 then 1½–2 percent p/a; - CDEL 2 percent p/a real growth to FY2029/30 then 1½–2 percent p/a; - AME rises with population growth and inflation on average over time. - High Spending Scenario: - RDEL real growth of approx. 3.5 percent p/a in all years; - CDEL real growth of approx. 3.5 percent p/a in all years; - AME rises with population growth and inflation on average over time. - Functional expenditure assumptions (selected highlights): - Health: - Real growth of 3½ percent p/a all years to fund NHS workforce plan (both scenarios). - Education: - Central: Maintain at 4½ percent GDP until FY2029/30, then decline to 4 percent GDP as student numbers fall. - High Spending: Increase gradually over horizon to 5 ½–5¾ percent GDP (pre-GFC level). - Social Protection: - State Pension: Increase in line with OBR 2023 MT estimates, adjusted for 1yr rise of retirement age FY2026/27 (both scenarios). - Social Care: - Central: Real growth of 4.3 percent p/a all years to meet demand & improve access (Health Foundation est.). - High Spending: Real growth of 6 percent p/a to meet demand and fully cover user costs. - Other Social Protection (incl. benefits): Rise with population growth and inflation in all years (both scenarios). - Housing and Community Amenities: - Central: 5 percent real growth (2028–23 avge) p/a to meet demand for social homes; constant in percent of GDP after FY2029/30. - High Spending: 11 percent real growth p/a (pre-GFC average) to meet demand for social homes, until FY2029/30, then average real growth of 3 percent p/a. - Transport: - Central: After recent increases, maintain at 2 percent GDP until FY2029/30, then at FY2028–23 average of 1.8 percent GDP. - High Spending: After recent increases, maintain at 2 percent GDP in all years. - Environmental Protection: - Central: Maintain current percent GDP (0.4–0.5). - High Spending: Increase to 0.6 percent GDP (2000–10 avge). - Defence: 2½ percent GDP per year (both scenarios). - Public Order & Safety: - Central: Maintain 2010–19 avge (percent GDP). - High Spending: Increase real growth to 3.8 percent p/a, average of past 5 years and 2000–10 average, including capital spending. - General Public Services (including ODA and Ukraine aid): Maintain percent GDP until FY2028/29 then gradually return to 2010–19 average (both scenarios). - Economic Affairs (including Sc. & Tech; Economic Aid (energy crisis); agriculture & fisheries): - Central: Return economic aid to 2010–19 avge by FY2029/30; maintain others in percent GDP. - High Spending: Return economic aid to 2010–19 avge by FY2029/30; increase ag. & fisheries spending to 2000–10 avge; maintain others in percent GDP. - Recreation, culture and religion: - Central: Maintain in percent GDP. - High Spending: Increase to 2000–10 avge. - Note: Around 60 percent of local authorities in England do not have an up to date plan (contextual detail in source). ### Construction Planning System: Constraints, Costs, and Economic Effects - Characterization: - The UK construction planning system is overly stringent, localized, discretionary, and unpredictable, inhibiting new construction (residential and commercial) and infrastructure projects. - Local decision-making often prioritizes short-term local issues and can ignore wider regional and national externalities, increasing susceptibility to vested interests, lobbying, and NIMBY problems. - Quantified impacts and literature findings: - Planning permissions can increase development costs by up to 10 percent. - Since 1945, almost 4.3 million fewer houses were built due to planning restrictions (close to a fifth of the housing stock). - Hilber & Vermeulen (2016) estimate that in the absence of regulatory constraints, prices would have been 35 percent lower in the 2000s than they actually were. - The UK has seen no increase in the amount of built-up land per capita since 1990, in contrast to other G7 economies. - In the 1950s, 70 percent of UK residents owned house by age 34; that figure has fallen to less than 34 percent today. - Economic consequences: - Stringent planning has contributed to a depressed rate of UK business investment (as a share of GDP) relative to the 2000s and a loss of investment to peers with less stringent regimes—especially in data centers and life sciences. - Planning restrictions create barriers for net zero infrastructure investment, including new onshore wind farms, solar farms and grid connections. - The National Infrastructure Commission (NIC) estimates easing planning and delivery constraints in the Milton Keynes-Cambridge arc could double its contribution to UK growth by 2050 and triple the creation of new local jobs. ### International Comparisons and Reform Examples - System types: - UK, Canada, US, Ireland: Markedly discretionary and predominantly administered at the local level. - Germany, France, Netherlands: More rule-based with decision-making authority centralized at national or regional level. - International reform examples: - Israel: - Community and developer collaboration on neighborhood renewal (Tama 38; Pinui-Binui) with incentives such as new or larger apartments and added density allowances. - United States (Houston, Texas): - Regulations empowering landowners to densify their properties; emphasis on "gentle density" leading to significantly lower house prices than restrictive cities. - New Zealand (Auckland, 2016): - Upzoned approximately three quarters of residential land; created three residential zones allowing 5–7 story, 3-story, and 2-story dwellings respectively. Resulted in a construction boom and prevented a significant rise in housing prices and rents elsewhere in New Zealand. - Greenaway-McGrevy and Phillips (2023) found upzoning prompted additional construction in Auckland, resulting in more than a four-fold increase in the trend rate of construction compared to areas without upzoning. ### Policy Recommendations and Reform Directions - Focus reforms on systemic changes that reduce discretionary decision-making in granting permissions; concrete areas for progress: - Broader geographic and rules-based decision-making for business and large residential developments to reduce investor uncertainty. - Digitalized and standardized plans at the local level which are binding for designated growth areas. - Careful review of scope to release Green Belt land of little environmental or amenity value near stations with easy access to major cities. - Targeted incentives to overcome resistance to new builds and resources to local authorities, including skilled staff to facilitate compliance with new environmental requirements. - Emphasize community-driven approaches and incentives to align resident and developer interests, drawing on international examples that combine local engagement with streamlined delivery. *Source: IMF staff analysis and projections excerpted from the provided chapter.* ### 6. Success stories are also available from within the UK, such as Croydon, London. The ### 6. Success stories are also available from within the UK, such as Croydon, London. The ### Croydon case and lessons - The borough introduced planning guidance in 2018 that allowed homeowners to convert single-family homes into apartments, which "significantly boosted supply and affordability when compared with the rest of London." - The Croydon suburban design guide supplementary planning document (SPD2) was adopted in April 2019 and revoked in June 2022. - The episode demonstrated: - small-scale densification can produce tangible supply and affordability gains; - swift repeal in the wake of a contentious election underscored the challenges and the need for flexibility to ensure long-term viability of regulations; and - political opposition can reverse reforms rapidly, highlighting the need for better ex-ante communication to explain benefits to local communities. ### Potential reforms to the UK construction planning system (overview) - Recent national planning policy has seen "intermitted reforms," but a fresh and ambitious impetus is needed due to: - disrupted momentum from shifts in priorities, political hurdles, and community opposition; - stop-start dynamics that widen the gap between policy intent and practical outcomes; - added burdens on local authorities from compliance with new environmental and safety requirements, and shortages of skilled staff (for example, "egologists"); and - anemic investment and declining labor productivity, particularly total factor productivity. - A comprehensive overhaul should focus on systemic reforms that: - reduce discretion in granting permissions; - ensure certainty and align housing supply with demand; - address complexity, delays, high costs, and unpredictability; - attract investment, expand better-quality affordable housing, and facilitate the green transition. ### Tangible, politically feasible areas for progress - Broaden geographic coverage and adopt rules-based decision-making: - broader geographic and rules-based decision-making for business and large residential developments to reduce investor uncertainty; - adopt a stricter framework for proposal evaluation, backed by up-to-date and binding local plans to make it more difficult for local councils to reject compliant proposals. - Digitalization: - digital tools can streamline processes, standardize decision-making, facilitate data-driven decisions, optimize resource allocation, and support real-time monitoring and evaluation; - public engagement through online platforms can foster transparency, inclusivity, and trust. - Select release of Green Belt land: - releasing Green Belt land with "minimal environmental or amenity value" for developments near transit stations with convenient access to major cities could address housing shortages in high-demand areas without negative social or environmental impacts; - development charges on released land could generate "substantial funds for rail services, social housing, infrastructure, and local community services"; - establish Green Development Corporations (GDCs) for each city region with planning authority and revenue allocation control from proposed development charges. - Additional measures to manage opposition and accelerate delivery: - objection thresholds, incentives for compliant projects, and penalties for delays to minimize unnecessary opposition and reduce bureaucratic bottlenecks. ### Box 1 — Political opposition to recent planning reforms - The 2020 Planning for the Future White Paper proposed a shift to a more "rules-based" approach by classifying land into growth, renewal, and protected areas, digitizing planning, replacing Section 106 with an infrastructure levy, and making local codes subject to community involvement. - Anticipated outcomes included shortening the planning process to 30 months, updated local plans for all areas, technology-enabled accessibility, a simpler national levy, a fast-track system for attractive buildings, and mandating new homes to be "zero carbon ready". - Heavy criticism during consultations led to delays and a more cautious final legislation: - zoning reforms were revised and scaled back; - simplifying local plans and increasing digitalization were adopted; - the consolidated Infrastructure Levy was "weakened and reevaluated"; - housing targets were compromised amid backlash. ### Incentives, resources, and tax reform to drive local delivery - Invest in local authorities with incentives and resource allocation to overcome NIMBYism, including: - financial grants, technical assistance, and capacity-building programs; - linking funding to planning performance and the achievement of sustainable development goals; - allowing local authorities to retain more revenues generated by new developments for local benefits. - Tax reforms to spur mobility and investment: - lowering the Stamp Duty for both residential and non-residential properties (Stamp Duty is "associated generally associated with lower residential transactions"); - reforming the council tax (to ensure "at least revenue neutrality") to reduce barriers to high-growth firms, spur investment, and improve workforce mobility; - note: reducing or removing Stamp Duty could "improve property allocation and limit moving costs" while council tax reforms would impact owner-occupied residential properties and local businesses. ### Skills and timing considerations - Given spending pressures and a large public infrastructure push, bold planning reforms are argued to be "less costly in fiscal terms" at the current conjuncture than later—yet a large infrastructure push "will be difficult to achieve" now. - Reforms require addressing local authority capacity constraints and shortages of professionals needed for environmental and safety compliance. ### Key summary recommendations - Prioritize politically feasible, focused reforms around: 1. broader geographic and rules-based decision-making; 2. digitalization and standardization, with binding local plans for designated growth areas where feasible; 3. careful release of Green Belt land near commuter stations that is not of "significant environmental or amenity value"; 4. targeted incentives and resources to local authorities, including fiscal and tax measures (Stamp Duty and council tax reforms). *Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1gbrea2024002.pdf* ### 3. Skills gaps have also increased in the existing workforce (i.e., already-hired workers), ### 3. Skills gaps have also increased in the existing workforce (i.e., already-hired workers), ### Extent and measurement of skills gaps and shortages - 15 percent of employers report that at least one member of staff is not fully proficient in their role (up from around 13 percent in 2017). - The density of the skills gap (employees judged not fully proficient as a proportion of all employees) increased from 4.4 percent in 2017 to 5.2 percent in 2022. - The 5.2 percent in 2022 was equivalent to 1.72 million employees, compared with 1.27 million in 2017. - Nearly a third of companies reported that the lack of availability of skilled labor limited firm output. - Smaller firms, with 2 to 4 employees, were more likely to report that skills gaps had a major impact. ### Sectoral patterns and impacts on output - Skills-shortage vacancies and skills gaps are present across sectors; surveys indicate skilled labor as a limiting factor to production (survey horizon “expectations for next 3 months, 12MMA” series shown across 2000–2023). - Employer surveys and industry censuses (e.g., engineering and construction industries) show about half of employers in those sectors faced hiring difficulties in 2021; about 65 percent of those employers attributed difficulties to candidates not having necessary qualifications and experiences. - Institute of Physics research found that a majority of physics-powered businesses faced slowdown or halted R&D investment due to lack of employee skills. ### Cross-country mismatch indicators (OECD measures, 2019 data unless otherwise noted) - Field-of-study mismatch: almost 40 percent of UK workers have a field-of-study mismatch compared to an OECD average of 31.7 in 2019. - Qualification mismatch (average percentage of workers whose qualification does not match job requirements): - Underqualification in the UK: 40.5 percent. - OECD average for underqualification: 34.4 percent. - OECD estimates such mismatches can lower productivity, increase unemployment, and limit global competitiveness. - Learning and Work Institute estimate: UK skills shortage will cost £120 billion by 2030, with a shortfall of 2.5 million highly skilled workers and an oversupply of more than 8 million people with low skills. ### Factors driving skill shortages - Evidence points to weakening educational outcomes, declines in adult education, Brexit and COVID shocks, and population aging as contributors. - Public funding: despite an increase in public funding for primary and post-secondary education since 2019 (reversing earlier cuts), outcomes—particularly science scores—have declined over the past two decades. - Employer investment in skills: total employer investment in skills declined 19 percent per employee, in real terms, between 2011 and 2022, with sharper declines in: - larger businesses: -35 percent, - primary sector: -44 percent, - public service sectors: -38 percent. - Migration: increase in non-EU migrants since Brexit has not directly offset the loss of EU-workers given different skillsets and hurdles in hiring non-EU workers, especially for small firms. ### Primary and secondary education—spending and outcomes - UK public spending on primary to post-secondary education institutions was 3.7 percent in 2020 (above the OECD average of 3.3 percent). - Spending as percent of GDP declined from 2013 to 2018 with a small increase in 2020. - IFS 2023 estimate: 9 percent real terms fall in spending per student from 2010 to 2020, driven by a small (1–2 percent) increase in total spending on schools combined with an 11 percent increase of student numbers. - Primary schools: experienced real-term growth in spending per student. - Secondary schools: experienced real-term cuts. - PISA performance: UK mean performances in reading, mathematics, and science have declined over the past two decades and notably from 2018 to 2022 (COVID disruptions are a partial explanation). - Distributional change: since 2006 the lowest achieving 10th percentile in mathematics has performed worse over time while the top 10th percentile did not change significantly, suggesting widening disparities. ### STEM education supply constraints - Only 26 percent of UK graduates are from STEM courses (compared with 25 percent in France, 23 percent in Spain, and 20 percent in the U.S). - A-level STEM participation increased from 258,790 in 2019 to 276,641 in 2023. - Significant and increasing gender gaps exist in subjects like Mathematics, Physics and Computer Sciences (A-level gender gap data indicate notable male-minus-female differences across STEM subjects). - Teacher shortages and recruitment/retention challenges exacerbated by real-term falls in teachers’ pay (Teacher Labour Market in England Annual Report 2023 cited as evidence); recruitment shortfalls particularly acute in physics, design and technology, and computer sciences (these subjects recruited less than a third of their respective initial teacher trainee targets). - Suggested areas needing attention: student interest, gender gap, and increasing number of teachers with relevant STEM qualifications. ### Vocational training, T-levels, and apprenticeships - Improving T-level and vocational training is essential for sectors with skills-shortage vacancies (construction, information and communication, manufacturing, health). - Student-to-teacher ratio in vocational programs: 24.7 to 1 in the UK compared to the OECD average of 15 to 1 in 2021. - Upper secondary vocational graduates: only 7.9 percent of UK graduates are in in-demand sectors such as engineering, manufacturing and construction programs compared to an OECD average of 31.8 (OECD 2021). - Awareness and uptake constraints: understanding of T-level programs is relatively low for both learners and employers, constraining uptake. - Apprenticeships: - Apprenticeship starts peaked in 2011 and decreased throughout the 2010s. - Younger workers (under 24): apprenticeship starts almost halved after the pandemic. - Apprenticeship starts for ages 25+ remained stable. - High level apprenticeships (higher and degree-level, equivalent to at least NQF Level 4) tripled since 2017. - Intermediate level apprenticeships (equivalent to NQF Level 2) have fallen sharply, bringing down overall participation. ### Key statistics (preserved verbatim) - Employer reports of at least one staff not fully proficient: 15 percent (2017: around 13 percent). - Density of skills gap: 4.4 percent in 2017; 5.2 percent in 2022. - Employees lacking full proficiency: 1.72 million (2022); 1.27 million (2017). - Field-of-study mismatch (UK): almost 40 percent (2019); OECD average: 31.7 (2019). - Underqualification (UK): 40.5 percent; OECD average: 34.4 percent. - Estimated cost of skills shortage by 2030: £120 billion. - Skills shortfall and oversupply by 2030: shortfall of 2.5 million highly skilled workers; oversupply of more than 8 million people with low skills. - Public spending on primary to post-secondary education institutions (UK): 3.7 percent in 2020; OECD average: 3.3 percent. - IFS estimate: 9 percent real terms fall in spending per student from 2010 to 2020. - Employer investment in skills per employee (2011–2022): -19 percent (real terms); larger businesses: -35 percent; primary: -44 percent; public sectors: -38 percent. - Share of UK graduates from STEM courses: 26 percent. - A-level STEM entries: 258,790 in 2019; 276,641 in 2023. - Vocational upper secondary graduates in in-demand sectors (UK): 7.9 percent; OECD average: 31.8. - Student-to-teacher ratio (vocational, UK): 24.7 to 1; OECD average: 15 to 1. - Apprenticeship trends: high level apprenticeships tripled since 2017; younger apprenticeship starts (under 24) almost halved after the pandemic. *International Monetary Fund, UNITED KINGDOM — selected findings from chapter on skills gaps and labor shortages.* ### 12. Public spending on tertiary education has plummeted in the last decade while private ### 12. Public spending on tertiary education has plummeted in the last decade while private ### Tertiary education financing shifts - Overall spending on tertiary education increased in the UK and is higher than other G7 countries except for the US and Canada in 2020. - UK public spending on tertiary education institutions halved from 1 percent of GDP in 2012 to 0.5 percent in 2020. - Private spending on tertiary education in the UK increased from 0.7 to 1.5 percent of GDP between 2012 and 2020. - UK public spending on tertiary education institutions is well below OECD average in 2020. - Tuition fees from non-UK students in England in the 2021–22 financial year: - Accounted for 42 percent of higher education course fees. - Accounted for 21 percent of all income for universities in England. - Some universities in London received more than three-quarters of higher education fees from non-UK students. - Consequence: Tertiary education finances are more volatile and exposed to changes in immigration policy affecting visas and enrollment, with potential impacts on research, performance, and skills attainment. ### International students and labor market impacts - Graduate Visa Scheme permits students to stay in the UK for 2 years to conduct job searches post-graduation. - Inflows and visa sponsorship: - The Graduate Visa Scheme resulted in a more recent influx of visa holders and a large increase in yearly sponsored study. - Retention and integration caveats: - If foreign students return to home countries after education, their direct impact on UK skill shortages is limited (except indirect effects via subsidizing UK students). - The Migration Conservatory’s analysis of ONS population survey in 2022 indicates highly educated foreign-born workers are often overqualified: the percent of highly educated foreign-born (including some EU born) workers employed in low and medium skilled jobs were above that of UK born workers. - Policy and market changes affecting retention and recruitment: - Postgraduates are now restricted from bringing their families to the UK. - Enroly data points to a decline in enrollment from several countries since 2023. - Management consultancies (KPMG, Deloitte, and HSBC) cancelled job offers to non-UK recruits after the threshold for skilled visa workers was raised from £26,200 to £38,700 in 2024. ### Adult and workplace learning - Participation: - Participation in adult learning and skills development declined over the past decade across most qualification levels, with a slight recovery over 2021-2023. - Total participation counts and breakdowns are documented in ILR-derived charts for Apprenticeships, Community learning, Other education and training, Workplace learning, and Total further education and skills (Adult (19 Years+) Further Education and Skills Participation, Thousands). - Funding and investment: - Total public spending on adult skills dropped 30 percent from its peak in the early 2000s. - The Learning and Work Institute estimates per capita funding for adult skills decreased in real terms by 28 percent between 2010/11 and 2022/23. - Companies reduced the amount of investment by 20 per cent per employee between 2010/11 and 2022/23. - In England, the decline in the number of adult learners in the most disadvantaged areas was almost 10 times above the decline in the most advantaged. - Workplace training trends: - Overtime, the proportion of older workers who received workplace training increased 4.5 percent on average for men and 3.0 percent on average for women between 2005 and 2023. - Younger people’s participation in workplace training has slightly decreased over time; women receive less training overall and, due to higher shares in part-time work, typically undertake shorter training than men. - By occupation, workplace training declines were largest for managerial and professional occupations, the public sector, and services. - Employers’ average investment in training metrics are tracked (Investment in training per employee; Investment in training per trainee; Average Investment in Training) with series spanning 2011–2022. ### Brexit and migration effects on skills supply - Migration patterns: - Over two decades migrants, including from the EU, helped fill short-term skills gaps. - Post-Brexit the gap between non-EU born and EU-born workers has widened significantly since Brexit. - Surge in non-EU migration suggests some substitution between EU and non-EU labor, but notable differences exist in labor market outcomes, matching, and employment share by industry. - On average, non-EU migrants experience higher unemployment rates than EU-born and UK-born workers. - Visa issuance patterns: - Home Office Immigration Statistics indicate studying and work are main reasons for visa issuance; issued visas by category and quarterly moving averages are documented (Family, Other, Study, Work, Dep. joining or accompanying). - Sponsorship and employer-size effects: - Pre-Brexit, many occupations (managers, professionals, skilled trades, sales and customer services) relied substantially on EU workers. - Post-Brexit, many of these occupation groups have extremely low rates of sponsorship in 2023 relative to their pre-Brexit EU worker reliance, creating voids and skills gaps. - Small and medium sized firms that relied on EU labor face complexities and expenses hiring non-EU workers; large firms dominate sponsorship of foreign workers while small and medium employers largely stay out of the system. - Employer sponsorship rates by firm size (Small 10-49, Medium 50-249, Large 250+) show larger employers more likely to sponsor non-UK skilled workers. ### Policy recommendations - Overarching goal: Address skills gaps to sustain economic growth and develop workforce skills for the future, starting from primary and secondary education and extending to lifelong learning and skilled migration in the interim. - Specific recommendations: - Reforms to primary and secondary education with emphasis on STEM: - Set ambitious targets consistent with a reversal of recent decline in STEM outcomes. - Encourage students and younger workers, particularly women, to enter digital, engineering, creative subjects, and technical education programs, and improve retention. - More and better-quality vocational training and apprenticeships: - Increase vocational graduates in key areas such as STEM. - Encourage awareness and uptake of T-levels and other vocational programs. - Increase quality of vocational programs and improve student-to-teacher ratios (currently below average relative to OECD). - Reverse decline in apprenticeships for the young and improve quality, including reforms to the apprenticeship levy. - Keep a stable student visa regime and encourage high-skilled students with in-demand skills to remain in the UK: - Given the increased importance of international student tuition fees as an offset to declining public investment in tertiary education, a stable and attractive UK student visa regime is critical. - Efforts needed to retain and fully integrate high-skilled graduates in the UK labor market. - Continued focus on lifelong learning and on-the-job learning, particularly for younger workers: - Build on the lifelong learning entitlement from 2025 which allows adult learners to access loans equivalent to four years’ worth of higher education to spend flexibly on degree or technical-level qualifications. - Encourage on-the-job training via further public support and focus on distribution; employers should improve access and incentives for training for younger workers. - Simplify worker visa regime to facilitate hiring by smaller employers who previously relied on EU labour pre-Brexit. ### Projections and skills demand - Sectoral job projections (Earning and Work Institute analysis, 2020–2035): - Science, research, engineering, and technology professionals: 1.9 million jobs to be filled due to sectoral change and retirements. - Business, media, and public service professionals: 1.8 million. - Caring personal service occupations: 1.7 million. - Administrative occupations: 1.6 million. - Health and social care associate professionals: 1.2 million. - Qualification-shift projections: - 3.5 million fewer jobs needing qualifications below A-level or equivalent. - 6 million more jobs needing higher education qualifications. - Policy implication: The UK must undertake ambitious reforms to prepare the workforce for a future concentrated in higher and professional occupations and increased demand for higher-level skills. *Source: 1gbrea2024002 - 12. Public spending on tertiary education has plummeted in the last decade while private* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1gbrea2024002.pdf_