By Richard Johnstone | 8 March 2013
The chair of the Office for Budget Responsibility has written to David Cameron challenging claims the prime minister made about the impact of government spending cuts on economic growth.
In a speech in Keighley in Yorkshire yesterday, Cameron stated that there was ‘not some choice between dealing with our debts on the one hand, and planning for growth on the other’.
He added: ‘As the independent Office for Budget Responsibility has made clear, growth has been depressed by the financial crisis, by the problems in the eurozone and by a 60% rise in oil prices between August 2010 and April 2011.
‘They are absolutely clear, and they are absolutely independent. They are absolutely clear that the deficit reduction plan is not responsible – in fact, quite the opposite.’
However, OBR chair Robert Chote today wrote to Cameron highlighting that every forecast since June 2010 ‘had incorporated the widely-held assumption that tax increases and spending cuts reduce economic growth in the short term’.
He said that the latest estimate from the OBR was that consolidation reduced gross domestic product by around 1.4% in 2011/12.
This is based on ‘multiplier’ calculations, which attempt to quantify the impact of different types of spending cuts on the wider economy. For example, a £100 reduction in capital spending is thought to reduce GDP in that year by £100, while the same reduction in welfare or other public spending reduces output by £60, with diminishing impacts in future years. The effect of tax increases is similarly estimated.
Chote added there is ‘huge uncertainty’ around these multiplier estimates, with the International Monetary Fund having recently revised its estimates for the multipliers in many industrial countries.
‘We have chosen estimates from within the wide range in the academic literature,’ he said.
‘Economic growth has been much weaker since the end of 2010 than we and most other forecasters expected in June 2010 and it is clearly possible that this is in part because the fiscal consolidation measures have had a greater multiplier effect than we anticipated.’
But the OBR has so far found inflation and financial difficulties in the eurozone are ‘more likely explanations’ for the lower-than-expected output.
He concluded: ‘To summarise, we believe that fiscal consolidation measures reduced economic growth over the past couple of years, but we are not yet persuaded they have done so more than the multipliers we use would suggest.’