The OBR has followed the Bank of England and downgraded its medium/long-term forecast of the growth in the productive potential of the economy. It now thinks only 1.6% is likely. This comes after 10 years of zero productivity growth has disappointed forecasts that were forever projecting the old growth rate of 2.5% to resume, something at the time that had a note of pessimism to it, since it was reasonable to speculate early on in the crisis that the productivity level extrapolated out from the old trend might one day be recovered [let alone the growth rate].
But this is not itself really news. It’s a revelation that one group of experts – who incidentally have no special insight into future productivity – have fallen into line with another. The depressing productivity data were there before budget day. We now know what the OBR made of them.
Another reaction that might be tempting from the Remainer tribe is: ‘You see! Brexit! I told you so.’ See, for example, these tweets:
But the forecast gloom was not really about Brexit. The OBR’s economic and fiscal outlook explains its Brexit assumptions on page 96:
This is – unless I am mistaken – a smooth transition to a Brexit that affects nothing. This is not on either account a Brexit that is likely to happen. We know from previous work [for example by the CEP / OECD / IMF /BoE] that anything but continued membership of the single market and customs union, transited to smoothly, will have significant negative consequences for GDP/head over the next 10 years. So if we layered on top of this forecast a probability-weighted sum of possible Brexits, the outlook would be substantially worse. Perhaps by something of the order of 0.5pp on growth each year, until the transition to our new, dislocated trading state is complete, and longer if the worse surmises about whether openness affects growth are proved correct.
Brexit gloom is not entirely absent. The Brexit story is in the depreciation of Sterling following the referendum; the subsequent predictable rise in inflation to 3%, the protracted adjustment downwards of real wages this means; and the slowing of growth relative to our trading partners. And this impulse will have made itself felt somewhat in the early part of the forecast.
Another thing to take away from the day is that the institution of the OBR is doing its job. At least, it is producing a forecast that seems plausible and unaffected by the tendency for Brexiters to taint comments about the future with unwarranted optimism. And there have been no personal attacks – unlike in the immediate aftermath of some of the Bank of England’s interventions. Recall, for example, these tweets:
Prior to the OBR, there was ample scope for fiddling the uncertain science of estimating potential output, and forecasting its expansion into the future, to make fiscal policy look more prudent than it really was. This time around, it is easy to imagine a world without the OBR in which Brexit Jacobins putting pressure on Philip Hammond to forecast that the future will be rosey, rather than simply make relatively anodyne comments about Brexit presenting ‘opportunities’. One wonders what fiscal policy would have been like in that world; contrasting it with the one we inhabit would provide a measure of the added value of the OBR.
For this to work the independence of the OBR has to be credible.
But not just that. We have to be convinced that they are not overstepping their remit.
One finance chat I am part of on WhatsApp [every self respecting economist has to WhatsApp-drop these days] included a caricature that its the OBR that actually sets fiscal policy. One can see the spirit in which this was meant. Imagine the government had figured out, finally, a scheme for setting fiscal policy [as it is often urged to do in these pages and those of other commentators]. In that case the OBR would come along with new forecasts, and the Treasury would simply crank the handle and set fiscal instruments appropriately.
Lurking there is the danger that the OBR might, or might be thought to taint the forecasts itself to bring about a particular mechanical following through of their consequences in fiscal policy. To prevent that, we can observe that in practice there are watchdogs of the fiscal watchdog: the Institute for Fiscal Studies, the Bank of England, and other external forecasters.
Another reaction to the forecast gloom was from Iain Martin. ‘Futurology is futile’ he tweeted above his Times piece. Unfortunately, futurology is essential. Why? Because there are long lags between deciding to do something with fiscal policy [or monetary policy for exampe] and those decisions having their full effect on the things that we care about [like growth, debt, inflation, cost of finance].
In the case of fiscal policy it can take quite some time between making a decision to spend more and having any effect on anything whatsoever [viz the myth of ‘shovel ready projects’]. So, in order to make sure that your fiscal instrument settings are doing the right things to what you care about you have to line up candidate alternative fiscal plans against what you forecast will happen to what you care about.
The OBR forecasts will no doubt prove to be wrong ex post. All forecasts are. But that won’t invalidate them as forecasts now. [Tired example: when I roll a six sided dice 10 times and get a total score of 60, my forecast of a 35 is not proved wrong]. If you are a technological pessimist, you might plausibly be tempted to extrapolate flat productivity from the last 10 years very far out into the future, and get forecasts that are much more gloomy than the OBR’s. If you are an optimist and think that the data is missing digital miracles, or that a stimulative fiscal policy could unleash a return to the old trend line, or at least its old slope, you would have a much more optimistic perspective. The OBRs forecasts are a finger in the air, but a reasonable one at that, and necessary.