- Productivity growth assumptions put the OBR at odds with the Bank of England
- Macroeconomic forecasts should inform policy, but to what extent should they drive it?
It seems only fair to start by stressing that macroeconomic forecasting is difficult.
The Office for Budget Responsibility (OBR) has to make assumptions about a wide range of economic variables each time it generates forecasts. This is difficult at the best of times, but has been particularly tough recently.
Fiscal policy has swung dramatically since Liz Truss’s short-lived mini-Budget plans, and energy prices and interest rates have also seen seismic shifts. Economists at Panmure Gordon note that expectations for peak interest rates in the UK have ranged between 4.25 per cent and 6.3 per cent over the past six months alone.
Shockwaves caused by the collapse of Silicon Valley Bank were still reverberating as the Spring Budget was announced, and economists at EY Item Club said that “some unexpected caution may need to be attached to the OBR’s less downbeat forecasts” as a result. Following the Budget, Richard Hughes, chairman of the OBR, told journalists at a press conference that “no central forecast survives six months, possibly six days, in an economy like the UK’s at the moment given the events going on here and going on in the world”.
But that doesn’t mean that we can’t give the projections a closer look. Take growth (see chart): the OBR expects real GDP to shrink by 0.2 per cent in 2023. This is disappointing, but still 0.3 percentage points above both the Bank of England and the average independent forecaster. The OBR is more optimistic over the longer term too, expecting 2.5 per cent growth in 2025, against the Bank’s 0.4 per cent. The OBR expects the UK economy to recover to its pre-pandemic levels by the middle of 2024 as a result – the BoE thinks it could take until 2026.
These divergences are driven by different assumptions about household savings, gas prices and, crucially, productivity. The OBR expects productivity to grow at a faster rate than it did after the financial crisis, whereas the BoE assumes that productivity growth will be similar to the 2010-19 average. Hetal Mehta, senior European economist at LGIM, believes that the OBR is still being “incredibly optimistic” about UK growth, and that “short of a productivity miracle occurring, this forecast is doomed to fail”.
We should also think hard about how much weight individual forecasts are given. The OBR’s projections are tailored to the task of assessing the government’s progress against the fiscal targets it has set itself, and are designed to increase accountability. When the OBR was established, then chancellor George Osborne hoped that the watchdog would “remove the temptation to fiddle the figures” – and the absence of OBR oversight did contribute to the uncertainty that followed the doomed Truss/Kwarteng Budget last autumn. But while these forecasts should inform government policy, to what extent should they drive them?
Last autumn, economists at the Progressive Economy Forum pushed back against the “dangerous fiction” of a “fiscal black hole”. They argued that the size of the supposed hole was completely dependent on uncertain forecasts and the government’s own rules, and should not be used to justify austere tax and spending measures.
A similar issue has emerged after the Spring Budget. One of the most significant policies introduced was “full expensing” of certain company capital expenditures – initially for a period of three years, although Hunt expressed hopes of making the change permanent “when fiscal conditions allow”. Crucially, the OBR does not expect the measures to have a long-run impact on the capital stock as a result, assuming that investment will simply be brought forward from future years.
The watchdog noted that “this would be different if the chancellor were able to follow through on his intention to make the measure permanent”. Paul Johnson, director of the Institute for Fiscal Studies, tweeted after the Budget that the situation has left “...the silly fiscal rules tail wagging the sensible fiscal policy dog” as a result. The implication is that the only reason the policy is not permanent is so Hunt can (narrowly) meet his own fiscal rule of debt falling as a share of GDP by 2027-28.
We must not disregard macroeconomic forecasts, but perhaps we should be wary of giving them too much weight.
