The last government made much of the supposed independence of the Monetary Policy Committee of the Bank of England. The present government places similar emphasis on the independence of the Office of Budget Responsibility.
Both bodies find forecasting their main targets difficult. The Bank of England has regularly had to revise its forecasts for inflation upwards in recent years. Over its lifetime it has shown substantial bias in its typical forecast by being too optimistic about inflation, the very thing it is meant to be targetting and controlling.
The Office of Budget responsibility has to forecast and help control the public finances. These turn out to be very sensitive to the overall economic growth rate. Given the fact that the government pockets around 40% of all the activity in the economy through taxation, government finances are much healthier when there is robust growth. In such conditions extra revenue comes in automatically without any need to change rates. In its first reappraisal of its growth forecast the OBR had to revise down both its 2011 and 2012 estimates. I do not ascribe much importance to its decision to increase its forecast for more distant years.
Errors in these crucial forecasts by the very bodies that have to make decisions or publish warnings based on them is dangerous for our economy and recovery. The Bank may have thought it was helping by keeping interest rates low, yet the inflation it unleashed over the last couple of years has done more to depress living standards than any other feature of our economic performance. The OBR’s early optimism over growth led to a downward revision of crucial figures for controlling the deficit within nine months of the first forecast. This has not yet mattered, but it will be important in the future that they have a better track record to keep market confidence in the figures and the system.
The OBR’s downward revision to the growth forecast for 2011 and 2012 will lose the country around £5 billion of revenue in a full year, a continuing loss unless and until the growth loss can be made up. Whilst this is not a large sum compared to the £1500 billion of National Income, it is a large sum in terms of the political debate. Some of the strongest arguments over spending and taxes in Parliament are over sums less than the £5 billion of error in the official June 2010 forecast.
It would be good if these official forecasters would apply a little more scepticism to the balance. It would be good to outperform the forecasts from time to time, to show they are as balanced and as accurate as possible. As we have been discussing this week, the government is going to need a strong and convincing growth policy if it is to hit the exacting OBR targets for growth in 2013, 2014 and 2015, when they expect growth each year to be well above the old trend, let alone the more recent one.