The Missing Link: Modelling Potential Output at the OBR

Jagjit S. Chadha

National Institute of Economic and Social Research (NIESR) Topical Briefings, 2023, issue 9

Abstract: Since 2010 the Office for Budget Responsibility (OBR), along with most other forecasters, has been consistently optimistic about the supply side of the economy, specifically with persistent overpredictions in the scale of productivity improvements These errors were largely driven by the statistical quirk of expecting a return to the mean rate of growth, rather than a structural analysis of emerging productivity trends. These forecast errors have contributed to misses in the fiscal targets, with debt-GDP not falling in line with plans, and to some loss of credibility in the fiscal framework. It has also introduced a deflationary bias in fiscal policy, as successive Chancellors have then tried to tighten fiscal policy in order to hit a(n arbitrary) target for lower Debt-GDP. Tightening has tended to focus on public investment, where net fixed capital formation has averaged some 1 per cent of GDP this century) and infrastructure, which ironically would do most to raise productivity. I suggest that public investment is excluded from the calculations on the accrual of Debt to GDP, perhaps in conjunction with a more considered analysis of the whole of the government balance sheet in terms of liabilities and assets. And that the OBR adopts a practice by which public expenditure can more clearly impact structurally on the supply side of the economy over a longer policy horizon and support fiscal sustainability, which may require reform of the existing legislation. Persistent biases in forecasts can lead to persistent errors in policy and instrument choice. One priority for the OBR, if it is to advise Chancellors on more optimal setting of fiscal policy, is to develop a better understanding of the impact of fiscal policy on both demand and supply in the economy. And to publish the impact on both of alternative policy choices.

Date: 2023-03
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