MNI INTERVIEW: UK's OBR To Cut Productivity Only Slightly-Bean
MNI (LONDON) - Fears the UK’s fiscal watchdog will ditch its assumption of a rebound in productivity growth over its five-year forecast period, sharply pushing up its projections for government borrowing, are likely to prove unfounded, though it could point to a slower recovery than previously indicated, a former top Office for Budget Responsibility official told MNI.
Productivity growth slumped to only 0.75% a year on average in the decade following the Global Financial Crisis, down from 2.25% previously, though the OBR’s last forecast had signalled a recovery to 1.25%, boosting projections for government revenues and so easing the fiscal burden. However recent data has been dire, with productivity even contracting in 2024, an unusual phenomenon outside of a recession, feeding expectations that the OBR’s next Economic and FIscal Outlook (EFO) on March 26 would reveal a downgrade.
But Professor Charles Bean, formerly both deputy governor at the Bank of England and a top OBR official, said the OBR is likely to only very gradually reduce its assumptions for productivity growth, particularly given the ongoing debate over the causes of its recent decline. While it could keep a return to around 1.25% in sight for now, achieving this level could be pushed back further into the forecast period, he said in an interview.
"If you keep the same assumption for the long-term and the hoped-for pick-up doesn’t show any sign of materialising in the recent data, then you are necessarily repeatedly pushing the start of the recovery out into the future. That means that, other things equal, projected productivity growth over the five years of the forecast will tend to get revised down a little at each EFO," Bean said following a Resolution Foundation event.
HEDGING BETS
The productivity trend forecast is "influenced by the data and state of research on the nature and cause of the post-GFC productivity growth slowdown. So the appearance of convincing evidence on this would likely prompt a change in [the] OBR’s assumption regarding the long-term trend. But in the absence of that, it’s likely that they would retain their 'hedge the bets' assumption for the long-term."
Chancellor of the Exchequer Rachel Reeves has set herself the goal of achieving current budget balance and debt falling by the fifth year of the OBR forecast, though this will gradually shorten to three years ahead. This task would be made considerably harder by a worsening productivity outlook, with the OBR having previously estimated that a 0.5% reduction in annual growth in the measure would raise borrowing by around GBP40 billion at the end of its five-year horizon.
The OBR is often described as more optimistic on productivity growth than others, including the BOE, but Bean noted that the Bank only runs three-year forecasts and is not focused on longer-term productivity. (See MNI POLICY: BOE Looks Set To Edge Up Neutral Rate Estimate)
"As far as the Bank is concerned, what matters to them is slack. Slack is the thing that drives inflation, amongst other things ... The OBR is the one outfit where actually the productivity assumption really does matter ... and that forces you to confront the question of, do you think the productivity slowdown of the last 15-20 years is the new normal or a temporary phenomenon?" Bean said.
OUTPUT GAP
Since the previous OBR forecast round in October output has come in weaker than expected, "the question then is whether that signifies a larger output gap than expected or whether it indicates the current level of potential output is lower," he said.
"The most important thing in the forecast is the OBR’s view of where potential output will be in the year for which the fiscal rules apply,” Bean said, adding that this depends on judgements of the size of the current output gap and growth in potential output between now and the target year.
"Direct indicators of slack, such as unemployment, vacancies, etcera, have been pretty much in line with expectations. Indeed if anything slack looks a bit smaller than expected," he noted, adding that this implies that the OBR's forecasts "may also involve a small reduction in the projected growth in potential output over the forecast."
Bean's successor at the OBR, fellow ex-BOE Monetary Policy Committee member David Miles, has questioned the logic of assuming stagnant productivity is here to stay. (See MNI INTERVIEW: UK Borrowing For Investment Risky - OBR's Miles )