Autumn forecast 2010 - Treasury Contents

Written evidence submitted by Ray Barrell and Simon Kirby, National Institute of Economic and Social Research (NIESR)[1]


We welcome the opportunity to submit evidence to the Committee's enquiry into the Office for Budget Responsibility's (OBR) Economic and Fiscal Outlook published alongside the Chancellor's Autumn Statement. This submission discusses the OBR's economic forecast in comparison to that of the National Institute[2].


1. The very robust growth seen in the second and third quarters of this year have led the OBR to revise up their projection for GDP growth for this year from 1.2 to 1.8%. The OBR's forecast for next year has been revised down from 2.3 to 2.1% per annum, but still remains more optimistic than that of the Institute. The different forecasts for GDP growth are presented in figure 1.

Figure 1


2. The major difference between the two forecasts is the contribution to GDP growth from consumer spending. The OBR expect consumer spending growth in 2011 of 1.3% per annum, whilst we do not expect it to grow. The divergence results from projection of 1.4 percentage point higher growth in real household disposable income in 2011. This would appear to be in part due to a higher level of employment in the OBR forecast than we would project given their output forecast. Nominal wage growth is the same in both forecasts. There also appears to be a rather strong contribution from the domestic components of household property income. There are additional but small effects on their forecast from both the projection for real government consumption and their optimism about business investment growth.

3. Beyond 2011 the main factor driving differences in our forecasts appears to be due to different views about consumer behaviour. Household saving weakened in 2010 as households maintained aggregate consumer spending growth in the face of falling real incomes. The OBR assume that the saving ratio remains broadly flat with consumer spending growing in-line with real disposable incomes (paragraph 3.45, page 44). We do not expect this to be the case.[3] As figure 2 shows, we expect this weakening of the saving ratio to be only a temporary phenomenon. Our forecast for consumer spending growth is based on an estimated equation where consumption is driven by real incomes and real housing and financial assets (reported in Barrell et al., 2003). Given developments in the determinants of consumer spending we would expect the household saving ratio to increase to around 6% over the period 2013-15.

Figure 2


4. Following the recent financial crisis we would expect household saving to increase from the low level we have seen recently, given the need for households to re-build their balance sheets and reduce the scale of their financial liabilities. Low saving in the last decade was driven by strong real house price growth and capital gains in housing. We do not expect this to be repeated in the next decade, and assets will have to be rebuilt by increased saving. But both forecasts present plausible scenarios for the future path of household saving. However, so is an alternative view that household saving could rise much more sharply over the next five year than even we expect, with the clear implication of an even weaker economic recovery.

5.  Table 1 gives an account of the changes to contributions to GDP growth between the two most recent OBR forecasts. This is an alternative approach to the presentation of forecast changes to that presented in table 3.7 (page 68)[4]. Some of the short term differences can be explained by recent data outturns. For example, the OBR have revised down the negative contribution of real government spending (consumption and investment) to GDP growth in 2011. The outturns for real government consumption to date: the estimate contained within the Output, Income and Expenditure statistical release from the Office for National Statistics (ONS) suggests real government expenditure continued to expand in the third quarter[5]. Simply including this estimate in our October forecast and assuming the same quarterly growth path from the fourth quarter of 2010 leads to a higher starting point for real government consumption next year; shrinking the contraction by 0.2 percentage points. This leaves a 0.6 percentage point difference between the June and November forecasts of the OBR to be explained.

Table 1

20102011 20122013 20142015
GDP0.6-0.2 - 0.0
Private consumption0.5 0.1-0.2-0.1 -0.10.0
Business investment0.0 0.0-0.2-0.1 -0.1-0.1
Dwellings investment0.3 - 0.10.0
Government0.10.2 0.1
Change in inventories0.1 - 0.00.0
Net trade-0.4 -0.2 0.0

Source: OBR, NIESR calculations.

Note: components may not sum due to rounding.

6.  As table 1 shows, the OBR have revised down their projections for consumer spending growth over the period 2012-14. In part this is a consequence of a downward revision to the OBR's house price projections[6]. Over the medium term our projection for house prices is significantly weaker, with house prices falling in real terms over the next five years. This would further slow consumer spending growth. The expected contraction in real government consumption and investment spending next year has been scaled back significantly. Given that the modification to cuts in Resource Departmental Expenditure Limits in the Comprehensive Spending Review are concentrated in 2013-14 and 2014-15, this implies changes to the assumption about the rate of inflation on general government consumption in 2011 and 2012. This leads to the question: is weaker government consumption inflation a consequence of a downward revision to the assumptions for public sector wage growth?

7. The OBR note that the level of employment has already reached the June forecast projection for mid-2012. However, three-quarters of the 350,000 increase in employment between the first quarter and third quarters are employed part-time. Data from the ONS suggest that there are now record numbers of the employed who are working part-time because they have been unable to find full-time work (over 1.1 million in the third quarter of 2010). Under such a scenario it is possible that job creation could slow dramatically as firms expand hours rather than employment as recovery becomes entrenched.

8. The OBR's report provides a good account of the uncertainties around their economic forecast. It would appear that the OBR calculates the chance of the economy contracting next year is around one in 10 (figure 3.4, page 39 of the OBR report). We think the chance is closer to one in six. The addition of alternative scenarios is a useful contribution to the understanding of uncertainties and risk related, not just to the UK economy, but also to the government successfully meeting its Fiscal Mandate.

9. Trend (or potential) rate of growth projections are central to this forecast. It is only with an estimate of trend that one is able to determine the cycle and therefore the cyclically adjusted measures used for the evaluation of fiscal policy against the Fiscal Mandate. One of the main actions by the interim OBR was to lower the expected rate of trend growth for future years. The permanent OBR have not revised the expectation of a trend rate of growth of 2.1-2.4% over the next five and a half years. Such a growth rate is broadly consistent with the estimates currently informing the Institute's forecasts for the UK economy. Trend growth can most easily be increased by increasing the labour force either through delaying retirement of increasing immigration. Neither seem to be in prospect over this forecast horizon.

December 2010


Barrell, R, Choy, A and Riley, R. (2003) "Consumption and housing wealth in the UK", National Institute Economic Review, No. 186, pp. 53-6.

1   Professor Barrell is Acting Director of the National Institute of Economic and Social Research. Simon Kirby is the lead UK forecaster at NIESR. Back

2   The Institute's latest forecast for the UK economy was published in the National Institute Economic Review in October 2010. Back

3   The OBR's forecast for real income growth may be stronger than the Institute's, but even this is weak relative to the past decade The OBR's projection is for real disposable income growth to average 1% over the period 2010-12. The average for the preceding decade is 2.1 per cent per annum. Back

4   Table 3.7 in the Economic and Fiscal Outlook presents the changes to the growth rates of the components of demand. Back

5   ONS (2010) Statistical Bulletin: UK output, income and expenditure - 3rd quarter 2010. Back

6   The OBR house price projection is based on the consensus in the short-term and then the assumption that house prices grow in-line with long-run average for earnings growth (paragraph 4.22, page 85). Back

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