Why we must get real on growth forecasts

Consistent over optimism in economic growth forecasts has served to justify excessive public spending, says Tim Knox at the Centre for Policy Studies.

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Tim Knox
On 27 May 2011 06:11

Optimism is a wonderful thing. The belief that things can get better is the cornerstone of all the most successful entrepreneurs, scientists and even politicians (think Blair, Thatcher and Obama).

But Candide showed us that there is such a thing as over-optimism. The old joke that an optimist is “someone who goes after Moby Dick in a rowing boat and takes the tartar sauce with him" illustrates how, when taken too far, optimism can even be dangerous.

And when we are dealing with official statistics which forecast the economic growth rate, we should surely seek accuracy. Sadly, it seems that the recent record of the Treasury in this area resembles a scaled down version of Captain Ahab with the tartar sauce.

A new factsheet, “Through rose-tinted glasses”, written by Ryan Bourne from the Centre for Policy Studies analyses the growth forecasts in Budget and pre-Budget reports since 1997. And it finds that Treasury forecasts of GDP growth have been consistently over-optimistic. 

In the period from 2000 to 2010, when it made its forecasts for three years ahead, it was over-optimistic on average by 1.3 percentage points. Looking just two years ahead, the same level of over-optimism was maintained. And even looking just one year ahead, the average level of over-optimism was 0.75 percentage points.

This matters. The growth forecasts are one of the bases for determining government spending and borrowing in the years ahead. They are used to decide departmental budgets. And if they have been consistently wrong – in one direction – then this may have had at least some part to play in the structural over-spending which the coalition government has inherited.

The paper shows that there are serious questions to be asked about official growth predictions in the UK economy.  Yes, of course, the inherent difficulties of macroeconomic forecasting should not be underestimated. But to be wrong again and again suggests that there must – at best – be some flaw in the Treasury’s methodology. At worst, it also raises the question of whether growth forecasts were manipulated for political reasons.

The Chancellor’s decision to set up the Office for Budget Responsibility (OBR) is therefore welcome. As an official, independent, fiscal watchdog the OBR – and not the Treasury – is now responsible for growth forecasts. But we must watch carefully to see whether the inherent, over-optimistic bias is eradicated. The last thing we need, in these times of austerity, are rose-tinted glasses.

Tim Knox is Acting Director of the Centre for Policy Studies.

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