By Richard Johnstone | 25 May 2011
A think-tank has warned that the government could miss its deficit reduction target due to over-optimistic growth forecasts.
Centre for Policy Studies researcher Ryan Bourne said that the Treasury’s forecasting record over the past ten years had proved to be consistently ‘rose-tinted’, providing ‘strong justification’ for the creation of the independent Office for Budget Responsibility in May 2010.
But he said that, if the flaws in the model used to predict growth were being replicated by the OBR, the economy will likely not expand quickly enough to meet the deficit reduction plans. Chancellor George Osborne wants to eliminate the structural deficit by 2015.
After analysing growth forecasts from both Budgets and pre-Budget reports, Bourne found the Treasury’s forecasting model tended to be ‘over-optimistic’.
Budget forecasts for growth both three and two years ahead exceeded the eventual figures by an average of 1.3% for the period from 2000 and 2010. Even forecasts just one year ahead were found to be out by 0.75%.
Bourne said that the ‘upwards bias’ in the forecasts were particularly evident from 2007 to 2010, when the recession hit. However, even focusing on the years of consistent growth between 2000 and 2006, it was on average 0.3% less than Treasury projected for a year ahead, and 0.5% for two years.
‘At best this evidence shows the difficulty of accurate macroeconomic growth forecasting. At worst, it provides strong justification for setting up the independent Office for Budget Responsibility,’ Bourne said.
Speaking to Public Finance, he added: ‘I am not saying that the Treasury system is wrong, but over ten years you would expect the discrepancies to even themselves out. There seems to be an upward trend in the model.’
The OBR was created to provide independent analysis of the country’s public finances, including growth forecasts. It publishes an annual forecast evaluation report to examine what lessons can be learnt from its own forecasting performance.
However, Bourne said that if the ‘consistent’ upwards bias is a feature of the model used by the Treasury and now by the OBR then it would be virtually impossible for the government to meet its deficit reduction targets on current projections.
‘We will not know until two or three years down the line when we analyse the OBR figures. If they were being massaged for political reasons [in the past] then we would expect that to be taken out, as the OBR is independent. But if it’s bias in the model then the government could miss its deficit reduction targets.
‘Their plan is based on pretty robust growth in the last three years of the Parliament and that is being forecast at the moment. But if these forecasts have the level of bias that we have seen in the past ten years then it will be virtually impossible for them to meet the target.’
A think-tank has warned that the government could miss its deficit reduction target due to over-optimistic growth forecasts.
Centre for Policy Studies researcher Ryan Bourne said that the Treasury’s forecasting record over the past ten years had proved to be consistently ‘rose-tinted’, providing ‘strong justification’ for the creation of the independent Office for Budget Responsibility in May 2010.
But he said that, if the flaws in the model used to predict growth were being replicated by the OBR, the economy will likely not expand quickly enough to meet the deficit reduction plans. Chancellor George Osborne wants to eliminate the structural deficit by 2015.
After analysing growth forecasts from both Budgets and pre-Budget reports, Bourne found the Treasury’s forecasting model tended to be ‘over-optimistic’.
Budget forecasts for growth both three and two years ahead exceeded the eventual figures by an average of 1.3% for the period from 2000 and 2010. Even forecasts just one year ahead were found to be out by 0.75%.
Bourne said that the ‘upwards bias’ in the forecasts were particularly evident from 2007 to 2010, when the recession hit. However, even focusing on the years of consistent growth between 2000 and 2006, it was on average 0.3% less than Treasury projected for a year ahead, and 0.5% for two years.
‘At best this evidence shows the difficulty of accurate macroeconomic growth forecasting. At worst, it provides strong justification for setting up the independent Office for Budget Responsibility,’ Bourne said.
Speaking to Public Finance, he added: ‘I am not saying that the Treasury system is wrong, but over ten years you would expect the discrepancies to even themselves out. There seems to be an upward trend in the model.’
The OBR was created to provide independent analysis of the country’s public finances, including growth forecasts. It publishes an annual forecast evaluation report to examine what lessons can be learnt from its own forecasting performance.
However, Bourne said that if the ‘consistent’ upwards bias is a feature of the model used by the Treasury and now by the OBR then it would be virtually impossible for the government to meet its deficit reduction targets on current projections.
‘We will not know until two or three years down the line when we analyse the OBR figures. If they were being massaged for political reasons [in the past] then we would expect that to be taken out, as the OBR is independent. But if it’s bias in the model then the government could miss its deficit reduction targets.
‘Their plan is based on pretty robust growth in the last three years of the Parliament and that is being forecast at the moment. But if these forecasts have the level of bias that we have seen in the past ten years then it will be virtually impossible for them to meet the target.’
