Sunday, February 05, 2023
Don't shoot the messenger bringing gloomy forecasts
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Economic forecasts have been in the news. Not since it organised a humiliating bailout of the UK economy in 1976 has the International Monetary Fund (IMF) attracted more headlines than it did a few days ago, or more criticism. At the heart of the criticism was a new forecast which, for the UK at least, was unremarkable.

The IMF’s prediction of a 0.6 per cent drop in gross domestic product (GDP) this year was less gloomy than the average new forecast by independent forecasters compiled by the Treasury, compiled by the Treasury, which is for a fall of 0.9 per cent. But it still produced a storm of “what do they know?” outrage, particularly as it coincided with the third anniversary of Brexit. I shall return to that.

On Thursday, after the IMF, the Bank of England announced a rise in official interest rates to 4 per cent, and hinted that this could be close to the peak. I am feeling a lot more comfortable with my prediction, first made during the Truss-Kwarteng blowout last autumn of a 4 per cent peak.

Less noticed was the Bank’s new forecast, for a milder recession that it predicted in November, because of a lower market path for interest rates and weaker energy prices. It nevertheless is for a recession, with GDP falling by 0.5 per cent this year and 0.25 per cent in 2024. That is a touch gloomier than the IMF, which predicts a 0.9 per cent rise in next year. Both are consistent with an economy that will feel flat, rather than falling sharply.

When forecasts are in the headlines, we have to get used to the “they’re always wrong” chorus from people who have no understanding of them. Forecasts are conditioned on assumptions, and getting those assumptions right has been extremely difficult at the start of the past three years.

At the beginning of 2020, nobody could have predicted the severity and economic consequences of the pandemic. A year later, when the vaccine rollout had barely started, it was hard to predict how effective it would be. This time last year, while the drums of war had started to sound, nobody could have accurately predicted the consequences of a Russian invasion of Ukraine. My annual forecasting league table in a couple of weeks will demonstrate the impact of that, particularly on inflation forecasts.

The IMF was actually a bit optimistic on the UK this time last year, predicting 4.7 per cent growth. The Bank was close to the likely 4.1 per cent outturn, predicting 3.75 per cent.

As it happens, the official forecaster, the Office for Budget Responsibility (OBR), has just published its annual forecast evaluation report. It concedes that it underestimated the extent of the rise in inflation, and also the strength of the economy’s recovery in 2021-22. But, as a result of official downward revisions to the level of GDP, its most recent forecast, last November, implies a weaker path than it earlier predicted. The economy is smaller than it was. In general, however, the OBR has tended to overpredict growth rather than underpredict it, it concedes, mainly because it has always anticipated the return of normal productivity growth, which has yet to materialise.

The Bank is also subject to something of an optimism bias when it comes to inflation. Professor Costas Milas of Liverpool University estimates that its two-year forecasts have underestimated inflation by an average (mean) of 0.66 percentage points, or a median of 0.37 points. It may be the wisdom of crowds but on his estimates, public inflation expectations (which tend to overestimate inflation) get closer what happens than the forecasts.

The message is clear. We should not automatically assume that forecasts are biased towards the gloomy. Often, the opposite is true.

The Treasury, under Jeremy Hunt, is as addicted to cherry picking the data as under any of his predecessors. Once it was aware of the IMF’s forecast, and the headlines it would generate, it put out a series of carefully-selected statistics, under the general heading of: “Alexa, five me some figures which show the UK in a good light.” I pity the poor officials tasked with this. This may be the chancellor’s way of addressing the “declinism” he thinks we are prone to. I can tell him that it needs a bit more than that.

The reason that forecasts for the UK economy are downbeat is that the economy has been stagnating for a year and that it does not take much it to continue stagnating, at best, or slip into a mild recession at worse.

Stagnating? Did not the economy grow by more than 4 per cent last year? Yes, in the sense that GDP last year was that amount higher, in real terms, than in 2021. But that apparently higher growth is a statistical quirk, largely due to the fact that GDP in the first quarter of last year was 10.7 per cent higher than its lockdown-affected equivalent quarter in 2021.

A better guide to the economy’s growth as experienced by households and businesses is growth “through” the year, in other words what happened between the beginning and the end. We have monthly gross domestic product figures up to November – December data will be published this week – and they show that GDP in November was exactly the same as in January. There was, in other words, no growth through the year.

This year, this stagnant economy faces higher taxes – corporation tax will go up sharply in April, as will income tax and national insurance as a result of the freezing of allowances and thresholds – as well as digesting the many interest rates rises announced by the Bank over the past 12 months. It is not surprising that the outlook is downbeat.

The best way to avoid recession forecasts is not to shoot the messenger but to accept that they are conveying an important message about the economy’s vulnerabilities.

The UK economy has shown itself to be vulnerable to a series of shocks, starting with the financial crisis, then Brexit, then the pandemic and the Russian invasion of Ukraine. Of these, the self-inflicted one, Brexit, is likely to be most damaging in the long run. It is also arguably, the easiest to fix.

The Bank’s gloomy assessment of the economy’s medium-term growth prospects, which it says reflects the economy’s very weak growth in supply potential, points the finger firmly at the weakness of exports and business investment, both consequences of Brexit. Indeed, it says that Brexit has affected business investment, which has been “very subdued” and will fall this year and next.

It will not win him any favours with some of his headbanger backbenchers but Rishi Sunak appears to recognise that. A new report from the UK in a Changing Europe think tank judges that in his first 100 days has largely maintained alignment with EU rules, something that most businesses want. They would also want a closer trading relationship with the EU, and a few weeks ago some senior ministers were talking of a “Swiss-style” set of arrangements. A closer relationship will evolve, but not just yet. In the meantime, we will probably have to get used to gloomy forecasts.