The economist J K Galbraith famously said there were two kinds of forecasters: those who don’t know, and those who don’t know they don’t know. Which sort is the Office for Budget Responsibility?
The question has been thrown into sharp relief by the International Monetary Fund’s mea culpa over ‘fiscal multipliers’.
Until recently, the Fund based its assumptions about the impact of fiscal contraction on a multiplier effect of 0.5. In other words, for every £1 of cuts in government spending, there would be a 50p dip in gross domestic product.
But at its October gathering in Tokyo, the IMF made it clear it had seriously underestimated the impact of austerity measures. Dismal global prospects mean that it now expects a multiplier effect of 0.9 to 1.7. (See Public Finance‘s November cover feature for Steve Freer’s take on the UK’s economic prospects)
If the actual multiplier is midway in the IMF’s range, the UK’s deficit cuts will have drained £76bn more out of the economy than anticipated.
This is bad news for the OBR, and for the chancellor. The government’s independent forecaster has already had to admit that its 2010/12 growth predictions were six times too optimistic.
Ahead of December’s Autumn Statement, the OBR has a choice. Either it owns up to having based its previous forecasts on outdated data. Or it carries on regardless – not knowing what it doesn’t know – and plucks another growth figure out of thin air.
For the Opposition, the multiplier mess is a gift. The potential negative impact on growth makes the West Coast Main Line fiasco look like small change by comparison.
Shadow chancellor Ed Balls claims that ‘expansionary fiscal contraction’ is dead in the water, along with George Osborne’s austerity strategy. A large body of economists is using the multiplier issue to ramp up pressure for a Plan B.
But how robust are these latest algorithms? As Tony Travers argues in the latest issue of Public Finance magazine, debates about numbers have an Alice in Wonderland quality: official statistics are not always what they seem.
And, depending on your view, it’s not just deficit reduction, but also high inflation, tight credit and weak global demand that have caused the disappointing growth figures.
With no recovery in sight, it is inevitable that disputes about growth should stir such passions. What is less clear is whether anyone has a clue as to what lies around the corner.
Prediction, after all, is very difficult – especially about the future.
This column was first published in the November issue of Public Finance magazine