Written evidence submitted by Ray Barrell
and Simon Kirby, National Institute of Economic and Social Research
(NIESR)[1]
INTRODUCTION
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].
THE ECONOMIC
OUTLOOK
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
NIESR AND OBR PROJECTIONS FOR REAL GDP GROWTH
(PER CENT PER ANNUM)
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
NIESR AND OBR HOUSEHOLD SAVING RATIO PROJECTIONS
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
CHANGES TO CONTRIBUTIONS TO GDP GROWTH IN
OBR FORECAST SINCE JUNE PROJECTIONS (PERCENTAGE POINTS)
| 2010 | 2011
| 2012 | 2013 |
2014 | 2015 |
| GDP | 0.6 | -0.2
| -0.2 | 0.0 | 0.1
| 0.0 |
| Private consumption | 0.5 |
0.1 | -0.2 | -0.1 |
-0.1 | 0.0 |
| Business investment | 0.0 |
0.0 | -0.2 | -0.1 |
-0.1 | -0.1 |
| Dwellings investment | 0.3 |
-0.1 | 0.0 | 0.0 |
0.1 | 0.0 |
| Government | 0.1 | 0.2
| 0.1 | 0.1 | 0.1
| 0.1 |
| Change in inventories | 0.1 |
-0.3 | 0.0 | 0.0 |
0.0 | 0.0 |
| Net trade | -0.4 | -0.2
| 0.0 | 0.0 | 0.1
| 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
REFERENCES
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
| 
