I was underwhelmed when George Osborne announced he was hiving off the task of fiscal forecasting to a new Office of Budget Responsibility (OBR). There's nothing in the OBR's first report, or in the initial reaction to it, to convince me that I was wrong. Many private sector forecasters seem convinced that the OBR, just like the Treasury before it, is too optimistic about the future, while the media and the politicians are using the report selectively to back up their preconceptions. No change there, then.
The downgrade in the growth forecast for 2011, to 2.6% from the 3-3.5% projection in the final Labour budget, has been widely reported as evidence that the previous Government was cooking the books. Truth to tell, in forecasting terms it's only a minor statistical adjustment. Both forecasts imply, almost certainly correctly, that the recovery from the credit-induced recession will be far from robust; the tenths of a percentage point shaved off the forecast are mere details.
A more alarming implication of the OBR forecast is that the credit crunch has permanently reduced the trend rate of growth of the economy, with an anaemic pace of expansion set to continue through the middle of the decade. I've even seen it reported that the economy will "never" recover the ground lost in the recession. I'm not sure what this can possibly mean. After all, real GDP will surpass its previous peak by about the end of 2012, if the OBR's forecasts are correct. It may be true that the structure of the economy will never be the same as it was back in 2007, but as the economy is always evolving, it's impossible to say a priori whether that's a good or a bad thing.
Alastair Darling has seized on the OBR's fiscal projections to demand an apology from the new Government for its frequent claims that Labour left the national finances in an unholy mess. On one level, he has a point: the actual deficit numbers for the last fiscal year were significantly lower than Darling forecast in his final budget statement. Despite its reduced growth outlook, the OBR projects a slightly less dire trajectory for the deficit (and hence also for the national debt) than the Treasury had forecast. In fact, the OBR report implies that Labour's claim that its measures would reduce the deficit by half over the course of the new Parliament was justified, which is certainly not what Osborne wanted to hear.
Naturally Osborne and his LibDem friends see this rather differently. They are pointing instead to the OBR's calculation that the "structural" portion of the deficit -- the part that won't go away as the economy moves back towards full capacity -- is somewhat higher than previously claimed, at about 8% of GDP rather than 7.3%. Calculating the structural deficit is such a complex matter that the difference between these numbers is relatively trivial, though that won't stop Osborne and pals from using the higher estimate to justify more aggressive fiscal tightening.
So, the stage is set for next week's emergency budget, and an early test of the usefulness of the OBR, all of whose new economic forecasts are based on the fiscal policy projections in the last Labour budget. If Osborne announces higher taxes and lower public spending for the next five years, those forecasts will be out of the window. If fiscal tightening significantly lowers the growth outlook, and thereby undermines the tax base, Osborne could easily preside over an era of pain with little gain -- slower GDP growth than the OBR is now expecting, with only nugatory improvements in the public finances compared to what Labour was set to achieve. So the main thing I'll be looking out for in the budget is the projected impact of the fiscal tightening on the growth outlook. Well, that and the possibility of a higher VAT rate on my still-pending car purchase.
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