Can we trust economic forecasts?

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dated: 2022-11-19 03:28:39 .

Chancellor Jeremy Hunt announced more than £50bn of tax rises and spending cuts on Thursday.

Hunt’s autumn statement was accompanied by an assessment of his actions by the Office for Budget Responsibility (OBR) – the independent spending watchdog that provides forecasts for the UK economy.

The chancellor quoted the OBR ten times during his speech but was criticized by some Conservative MPs. On November 14, former minister Jacob Rees-Mogg tweeted: “Mystic Meg’s predictions are more accurate.”

How much should we trust his predictions?

What do we use forecasts for?

Predictions give an indication of what is most likely to happen in the future.

Companies use them to plan where to invest, and the Bank of England to guide its interest rate decisions.

The OBR produces forecasts to check whether government spending plans are more likely to meet certain targets.

These targets, set by the government, not the OBR, tell us what spending will be like in three or five years’ time.

How good are the OBR’s forecasts?

The OBR was established in 2010 by then chancellor George Osborne to take over the task of assessing the government’s budgetary homework from the Treasury, a government department.

On Thursday, he forecast economic growth of 2.5 percent over the next three years: a recession year, a recovery year and then a year of additional growth.

This is very close to the average predictions of the group of forecasters who submit forecasts to the Ministry of Finance every month.

How accurate have the OBR’s predictions been in the past?

Ten of the 15 pre-pandemic growth forecasts (shown on the left in the chart below) were within two percentage points of final economic growth.

That’s slightly better than the margin of error the OBR gives in its forecasts, but two percentage points is still tens of billions of pounds for an economy the size of the UK.

Compare growth and borrowing projections with actual figures

The chart also shows that the actual growth numbers were fairly evenly split between exceeding OBR expectations (blue dots) and falling below those expectations (red dots).

This is a mixture of short-term pessimism (underestimating economic growth in the near future) and long-term optimism.

The OBR’s projections for longer-term growth have often turned out to be overly positive, largely because the OBR assumed we would become as productive as we were before the 2008 financial crash. That didn’t happen.

When it comes to the main task – checking whether the government lives within its means – the OBR has often been optimistic.

The right part of the graph shows that in most cases the state’s borrowing was higher than predicted by the OBR.

“These things are incredibly uncertain,” says Torsten Bell, who worked on economic forecasting at the Treasury before the OBR, but claims “this system is definitely better” than the one it replaced.

How does the OBR compare to other forecasters in the UK?

OBR has one major limitation that does not affect other forecasters. By law, she has to believe everything the government says.

If the government says “we’re going to raise fuel taxes next year” or “the holidays end in October”, other forecasters may consider changing those plans. OBR cannot do that.

Still, the accuracy of the OBR’s forecasts of the size of the economy this year or next looks slightly better than average compared to others in the Treasury’s monthly collection of forecasts. They are also pretty close to consensus.

And the OBR has advantages over others in forecasting government finances – privileged access to data from government agencies.

That makes his forecasts a “benchmark” for others looking at the impact of politics on Britain’s finances, says Sonali Punhani, economic forecaster at investment bank Credit Suisse.

What are the predictions for the UK?

The International Monetary Fund (IMF) says its forecasts for next year’s growth in advanced economies like the UK are mostly within about 1.5 percentage points of what actually happens.

The predictive reliability and performance of OBR are within this range.

But predicting recessions and recoveries is much more difficult than predicting pandemics.

IMF forecasters saw less than 10% of recessions a year in advance (and slightly more than half at the beginning of the year of the recession itself), according to its analysis of recessions around the world between 1992 and 2014.

What is the best way to read forecasts?

Because of all this uncertainty, it is hard to believe the ranking of the predicted growth years in the future.

You might be comfortable saying “Manchester City will still be challenging for the title in two years time”, but you still don’t say exactly where they will end up.

Experts “think less about the exact numbers than about the story they help tell,” Ms. Punhani says, “making different forecasts to see how things might change under different circumstances.”

The OBR report identifies the war in Ukraine, international gas prices and the cost of government debt as the main sources of uncertainty in its forecast.

Movements in any of these areas could cause the world to look very different than what is predicted today.

You can also compare different forecasters and find out why they are different and what this says about the economy.

For example, the OBR’s forecasts for the UK economy are more optimistic than those of the Bank of England, as the OBR expects people to continue to draw on their savings over the next year or two.

But none of them suggest that the next few years will be easy.

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Can we trust economic forecasts?

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