Ben Chu: The impossible job of an economic forecaster

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The Independent Online

"I don't know why you're laughing, it's a serious matter," snapped the Conservative MP David Ruffley at Robert Chote in yesterday's Treasury Select Committee hearing. But the chairman of the Office for Budget Responsibility would be advised to retain his sunny disposition because there is unlikely to be much for the Government's official fiscal watchdog-cum-economic forecaster to smile about over the next 12 months.

Last week the OBR downgraded its growth forecasts for the fourth time since it was established in June 2010. And even the present OBR growth forecast – for an 0.7 per cent expansion of GDP in 2012 – is based on the assumption that Europe's leaders will "struggle through" the present crisis and stabilise the continent's panicking bond markets. Despite the Franco-German agreement on EU treaty change this week, that still looks like an optimistic assumption. More growth downgrades from the OBR next year could fatally undermine its reputation as a forecaster.

But the real nightmare for the OBR lies not in growth forecasts, but in estimates of the "output gap". This is calculation that economists make to work out the size of the "structural deficit", or the proportion of national borrowing that will not disappear naturally when the economy picks up and tax revenues return to normal. If the output gap is large, the structural deficit is small. And if the output gap is small, the structural deficit is large.

The most significant news from last week was the OBR's downgrade of its estimate of the UK output gap. Because George Osborne has given himself a "fiscal mandate" to eliminate the structural deficit over five years, the Chancellor was compelled to pencil in still more spending cuts in order to meet his mandate. The OBR's output gap estimate led directly to a pledge for more austerity. And output gap estimates tend to be even more dodgy than growth forecasts.

The economist Roger Bootle suggested to the Treasury Select Committee on Monday that the Chancellor might dispense with the services of the OBR if the forecaster rules next year that the structural deficit has risen again and that still more fiscal tightening is needed. That would certainly be grotesquely unfair on Mr Chote and his OBR colleagues.

The fiscal mandate, with its strict five-year horizon and specific preoccupation with the structural deficit, was chosen by the Government, not the OBR. Mr Chote is merely doing what he was asked to do by Mr Osborne in making economic forecasts. And forecasts are inherently likely to be wrong because the future is so uncertain.

So Mr Chote should keep laughing: it's either that or tears.