1 December 2016
The futility of forecasts
Are predictions for the UK economy deliberately gloomy?
by Frank O’Nomics
It’s all very well wanting to “have your cake and eat it”, but the more important question is “how big is the cake?” The government’s investment plans announced in the Autumn Statement, designed to counter the potential slowdown resulting from Brexit uncertainty, would suggest that we are looking at a cupcake rather than a Victoria sandwich – but is this overly pessimistic? An economist I worked with liked to issue a guarantee with all of his forecasts. He said that in the event of any of his predictions being wrong, he would happily issue a new set of forecasts. As ever, there is much truth in jest and his guarantee helps to illustrate the futile nature of economic forecasting.
There are many problems with macro-economic forecasts; given that we start with imperfect knowledge about the present and have very little idea of the external influences that will impact the future. For those who have had to put together forecasts for the UK following last week’s Autumn Statement, most notably the Office for Budget Responsibility, these problems are particularly extreme, given the huge uncertainty over both the timing and the outcome of Brexit negotiations. However, the predictions have a significant influence on government policy which has the potential either to constrain an economy which needs and can afford a stimulus, or to result in overspending and a dangerous deterioration in the budget deficit. Whether the OBR has produced forecasts that are overly pessimistic is a matter for debate. Their growth forecast for next year has been revised down significantly from 2.2% in March to 1.4%, but is actually above the numbers produced by the Bank of England and the Treasury in the run up to the Chancellor’s speech. Whoever turns out to be right (and my guess is that it will be none of them) it will be entirely by accident, as all forecasters have been effectively flying blind, without any input from the government regarding their Brexit plans. The OBR themselves acknowledge this by saying that, while their central forecast shows that all the governments new fiscal targets up until 2020-21 will be met, there is a 35% chance of them being missed, despite their being £26.6 billion of headroom.
The OBR has to produce its forecasts on the basis of current stated Government policy, but as they have been given no information regarding the Government’s Brexit goals or expectations they have deliberately not tried to predict the end result of the negotiations. Their central forecast assumes that we leave the EU in April 2019, and they factor in uncertainty resulting in a delay in investment, together with the impact of a weaker currency, trade growth slowing through the period of negotiation and a tighter immigration policy; hence the lower growth numbers for next year. The problem with this is that recent data suggests that the economy is in a far more robust state than most of the official bodies have assumed. Yes, income tax receipts were weak in the run up to the referendum, but business investment and consumer spending have been strong, in spite of the high level of uncertainty. The latest ONS data shows business investment, far from falling an expected 1%, actually rose by 0.9% in Q3 and, while much of this may be the result of pre-referendum decisions, the OBR talk of investment next year being “postponed or cancelled” due to Brexit uncertainty has little supportive evidence as yet.
Household spending increased by 0.7% in Q3, suggesting that consumer confidence is also robust. This should not be that surprising given a strong labour market, rising house prices and improving credit conditions. The impact of sterling weakness was also evident in the data, with export volumes up 0.7% and imports down 1.5% – overall, trade delivered its biggest contribution to growth in almost 5 years. In total, GDP growth was +0.5% in Q3 and the OECD has already increased its forecast for 2016 to a whole to 2.0% from 1.8%, which compares favourably with their forecast for the Euro area of +1.7% (while they remain below the OBR forecast for the UK in 2017 at 1.2%, this is still an upward revision from 1%).
If the data suggests that forecasters may prove pessimistic, the impact of the Chancellor’s measures could be to push the divergence further. Press commentaries differed widely in their views as to the potential impact of the Autumn Statement, with the former Whitehall mandarin Nicholas Macpherson describing a “profligate rise in public spending”, but it is clear that the Mr Hammond, by resetting the government’s financial targets, has left plenty of room for manoeuvre. Further, despite the recent rise in bond yields, the price of funding a budget deficit remains remarkably low. Hence, the planned increases in infrastructure spending that were announced last week are very likely to earn more than their cost of capital, and so add to economic growth. The numbers involved are large, with spending on housing, broadband, roads and other infrastructure totaling £23 billion. If the growth and borrowing outturn proves to be better than forecast, then further measures to stimulate growth over the next few years may be affordable, and even if they are only in line, there is the OBR’s £26.6 billion of headroom that could be utilised.
If we want to take the cynical view, it seems that the Chancellor is comfortable in not giving the likes of the OBR any additional information regarding Brexit intentions, as this approach inevitably produces cautious (ie, low) forecasts for the economy. As we approach the election, which takes place towards the end of the forecast period, and the numbers for growth and borrowing are much better than expected, the Chancellor may have considerable scope to be much more generous. The OBR has admitted that its forecasts may look overly gloomy if the UK can secure new, more growth-friendly, trade deals. There may be some cake around after all.
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