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Treasury - Minutes of EvidenceHC 1910-II
Taken before the Treasury Committee
on Monday 26 March 2012
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr George Mudie
Examination of Witnesses
Witnesses: Robert Chote, Chairman, Office for Budget Responsibility Steve Nickell CBE, Member, Budget Responsibility Committee, Office for Budget Responsibility, and Graham Parker CBE, Member, Budget Responsibility Committee, Office for Budget Responsibility, gave evidence.
Q1 Chair: Thank you very much for coming in this afternoon. You have done another fat forecast for us. In your view, Mr Chote, given the way it is constructed, how much weight should people place on measures of the output gap?
Robert Chote: Necessarily, you have to place a lot of weight on measures of the output gap, because we have been tasked with policing a fiscal target that has been set in cyclically adjusted terms. By definition, we have to come up with a view of the size of the output gap at the end of the five-year forecast horizon to judge that. Even in the absence of a cyclically adjusted target, if you are going to take any sort of view of how activity is going to evolve over a five-year time horizon, as distinct from a much shorter one, it is hard not to take some sort of view implicitly or explicitly about the amount of spare capacity that there is at the moment and the growth rate of potential over that five-year period.
Needless to say, it is an extremely hard thing to measure. There is enormous uncertainty about it. We take great care to report the range of other views on the size of the output gap and the range of views on the evolution of potential. We have to do it, but I would be the first to say that it is an extremely difficult task, and it involves elements of art as well as science.
Q2 Chair: You are forecasting quite a number of variables here. In a scale of one to 10, where 10 is inaccurate and one is pretty much spot-on, where is the output gap in your list, as one that is likely to be off beam?
Robert Chote: The big difficulty with the output gap is that there is never a final, correct answer to compare it to, because it is not a directly measured variable. As we know, even with the directly measured variables, you can end up in the situation where what looks like a good forecast five years ago can look like a bad one 10 years ago. With the output gap there is no final, correct answer against which to compare it.
Q3 Chair: So therefore the answer to my question is you can mark your own prep.
Robert Chote: You are marking our prep, and everybody else who is looking at it is marking our prep. Clearly, one of the justifications for having the OBR is that the Chancellor is not marking his own prep. Arguably, that is a useful thing in itself.
Q4 Chair: But you are flagging up today the very high level of uncertainty that surrounds the output gap measure.
Robert Chote: Yes. If you look at the range of alternative estimates that we cite here, we are in line with the average at about 2.7% for 2011. The range varies from –½ to -4, so that gives you some sense of the variability.
Q5 Chair: Did you want to add something, Mr Parker?
Graham Parker: No.
Q6 Chair: You were nodding your head in vigorous agreement. On the other hand, Mr Nickell, you were not looking up at all, so it is difficult for me to know what you were thinking. Do you want to add anything?
Steve Nickell: Where we have put the output gap looks quite plausible to me, in terms of the amount of unemployment and that kind of thing, so 2½ sounds quite plausible to me-much more plausible than either a ½ or 4.
Q7 Chair: I am very pleased to hear that you do not think it is implausible, otherwise one would be wondering what was going on at the OBR.
Q8 Mr McFadden: Since we last saw you after your November report, your overall GDP forecast has not changed greatly, but there has been significant change within that about what will make up GDP growth this year. I want to ask particularly about household consumption. In November, you said household or private consumption would contribute only 0.1% to growth this year. You now say it is 0.3%. There was great criticism of previous economic growth, that it relied too much on household consumption and not enough on investment, manufacturing, trade and so on. Are the Government now relying, as they had hoped that they would not have to, more on household consumption to drive growth this year?
Robert Chote: You are right in characterising that the overall envelope for growth has not really changed very much since last time. We had a smaller contribution from investment and a slightly higher contribution from consumer spending. I don’t think that that is reflecting things that the Government have done in policy terms that have consciously attempted to-or inadvertently-shift that balance. There are two things going on there. In terms of the picture for consumption, we have edged that up a little. In part, in the short term it reflects the fact that we think consumption could be boosted a bit by payment protection insurance pay-outs, which might have a similar short-term effect on consumer spending of the sort that you saw from building society demutualisation payments, albeit at a much smaller level. Asset prices are slightly stronger in this forecast than in the previous one, and that might provide a further source of upward adjustment on consumer spending.
On the investment side, which is the main offset to this, you have two things going on. In the short term, we have had a significant downward revision to the forecast for investment growth in 2012, which is largely a reflection of the big decline in the fourth quarter of 2011. As you see from the recent path, we have very big swings in business investment from quarter to quarter. It is not at all unusual to see +5 or -5 or more than that from quarter to quarter. That can have quite an effect, particularly if it takes place in the fourth quarter, on the numbers for the following year.
Further out, we have also revised down somewhat our forecast for investment growth in the out-years of the forecast. There we have done two things, one of which is to look again at the health of the corporate sector’s balance sheet. Even more so than last time, our sense is that official statistics may be overstating the support that the amount of cash that appears to be on corporate balance sheets might provide to investment in the longer term. The ONS may be attributing such cash balances to industrial and commercial companies when they may be less likely to be there.
We have also had a look back at the sorts of growth rates and investment that we saw in the 1990s, and we looked at the comparison with this recovery. Basically, we now have investment picking up by about 40% over the five-year forecast horizon, which compares with about 50% in the equivalent period of the recovery in the 1990s. Given what is going on with fiscal consolidation, credit conditions, et cetera, a robust recovery in investment that is somewhat weaker than in the 1990s seems to us to be a reasonable balance.
I would say that there is that set of issues both on the consumer side and on the investment side, rather than the Government deciding to rely, or policy driving the Government to rely, more or less on one sort of growth or another.
Q9 Mr McFadden: Even if this is not decided by the Government, do you think a fair interpretation of the contrast between your review in November and your view in this report is that rebalancing has been delayed?
Robert Chote: If you define it as the contribution to the recovery that is coming from consumer spending versus investment, by arithmetic more is coming from consumer spending and less is coming from investment. I would not necessarily say that an investment story is being delayed in some sense. That depends very much on the near-term picture and what happens to the growth rate in 2012, which depends a lot on the data revisions we see to investment in 2011.
Q10 Mr McFadden: Your colleagues may come in on this. I just want to ask for a little more on consumption, retail spending and so on. Retail sales fell by more than expected in February, and January’s retail sales figures were revised down, too. Did you have access to that information during the preparation of your report?
Graham Parker: No.
Q11 Mr McFadden: In which case I have to ask you again about predictions that retail spending will rise. In the two most recent months we have seen lower than expected retail sales figures, so what gives you confidence, especially when Mr Chote’s old friends at the IFS have told us that the squeeze on household disposable income is the greatest since the second world war? With everything consumers are facing-petrol prices are through the roof and other costs are rising-what makes you think they will be able to engage in more discretionary spending than you thought a few months ago, Mr Nickell?
Steve Nickell: Our forecast is for consumption growth this year to be 0.5%, which, relative to the average in the past, is extremely low. In other words, we are simply forecasting-
Q12 Mr McFadden: It’s higher than you were predicting a few months ago.
Steve Nickell: Yes, that is basically for two reasons. One, the level of consumption towards the end of last year was higher than we thought because of data revisions. The other reason is that we have now incorporated the effect of payment protection insurance repayments to households, which adds a little to household income in the coming year. The increase over our previous forecast is not particularly great over the whole year. Basically, it relies on the idea that during this year incomes will grow reasonably steadily, but price inflation is falling fast. Whereas last year, as you rightly say, there was an enormous squeeze on real incomes because price inflation was much higher than earnings growth, in the coming year that is not going to be the case. By the end of the year, we expect earnings growth to start outpacing prices. That is why our consumption forecast is one of positive, though very modest, growth.
Robert Chote: It is a downward drag on the recovery until the point at which you start to see wage increases pulling significantly ahead of price increases, and so that is not until the out-years of the forecasts. Consumer spending is dragging the forecast down in the short term rather than pushing it up.
Q13 Stewart Hosie: Pat McFadden made the point that the GDP growth forecast from 2012 to 2016 has changed little between this forecast and the one last November. Would you say that there is more uncertainty in this forecast than in the November forecast?
Robert Chote: I wouldn’t say there was more uncertainty. I have an agreement with Steve that we will never use the phrase, "now is a uniquely difficult time to make a forecast", as it is always a very easy one to use.
The balance of uncertainties has changed a little bit. I think people are less concerned about the immediate financial consequences of difficulties in the eurozone as a result of the LTRO. People are a bit more concerned about the possible implications of higher oil prices than they were before, but that has been a change over a couple of months, and doubtless the balance of things to be worried about will change again in the coming months.
Q14 Stewart Hosie: So you have re-ranked those risks-the euro crisis down a little and oil prices up a little. Are there any other risks that you have re-ranked in this forecast?
Robert Chote: The oil price story is part of a broader one, which relates to the last question of how quickly will inflation fall. Will there be other factors-food prices, for example-that might mean that the fall in inflation is not quite as quick as the central forecast suggests, and therefore how soon will it be and with what strength will it be that earnings growth outpaces price growth? That remains an uncertainty, and it is not just down to oil.
Q15 Stewart Hosie: Obviously, those are drags on recovery. The Governor of the Bank of England has called for patience to allow space for current policies to work-this is on the up side. What would you say are the policies that are in train that will support the economic growth and demand that you are forecasting? What is the most significant policy area, change or development, either in this Budget or through this Budget, that will drive the growth you have presented?
Robert Chote: The main policy driver remains the accommodative stance of monetary policy. You have had some change in market expectations of where interest rates would go and, implicitly within that, what will happen to QE, but the foot clearly remains firmly on the accelerator on that score. In terms of the policy support, that will be a key one.
Q16 Stewart Hosie: Can I go back to some of the points raised by Pat McFadden? Looking at your last three forecasts-March 2011, November 2011 and the one this March-business investment is a huge driver of your forecast. In March 2011-these are for the same years-for 2010, 2011 and 2012, you said that business investment would grow by 2.5%, 6.7% and 8.9%. That changed six months later, for the same years, to 0.8%, -0.8% and then a rather heroic 7.7%. That has been changed again to -2.1%, 0.2% and 0.7% growth.
The oil price story isn’t new. The euro crisis isn’t new. Many of the other drags on economic growth aren’t new. How can you have these hugely differing business investment forecasts every six months, when they are so important-they are core and key to the economic recovery? Why are these figures changing so much?
Robert Chote: I point you to chart 3.14 on page 59, which shows you how volatile the data are for these figures on a quarter-by-quarter basis. Not only that, we have, for example, going back over last four quarters, which covers the period you have just been discussing, a decline of roughly 7%, followed by an increase of roughly 11%, followed by what looked initially like a fall of 2% but is now a rise of 1%, followed by a fall of 5% to 6%. Whenever you are doing these sorts of forecasts for investment, the near-term forecast is obviously reflecting, to a considerable degree, what the news is in the data that you have just had. That moves around a great deal. When it moves around towards the end of a calendar year, it has big implications for the year after that. As I say, looking further out into the future-this is also partly a story for the short term-we have obviously had changes in the degree to which the events in the eurozone might be regarded as being a drag on investment plans. In the longer term, you have a debate over to what extent investment is going to be affected by things such as firms’ confidence in the strength of demand over the long term and also the amount of money that they have available to invest, on which the information is frequently coming in and frequently changing, looking backwards and looking forwards, so I do not think it is hugely surprising that you see investment forecasts moving around quite a lot. It is inherently one of the more volatile series, and it swings-leaving aside the quarter-by-quarter volatility-around more than, say, consumer spending.
Q17 Stewart Hosie: I do not dispute the volatility at all. I am simply making the point that they were heroically high figures-I am sure that I have said this to you before-and they then fell and they fell and they fell. However, in this year’s forecast, you are still telling us that, on this forecast period of 2014, 2015 and 2016, we are still looking at 8.9%, 10.2% and 10.1% rates of growth. I am struggling to see how you can be so confident that we are going to get those high levels of growth when similarly high levels were forecast and then corrected down to effectively near zero.
Robert Chote: On confidence, I am always the first person to point out the uncertainties around these things. If you look at chart 3.15, you get some sense of the sorts of growth rates and investment year-by-year that you saw in the wake of the 1990s recession. There, three years into that recovery, you had 10%, 10% and 15%, so we have double-digit increases-just-in the last couple of years of this forecast, but we do not have anything like 15%. What we have is a relatively robust recovery. It is something that is increasing as a share of GDP, which we would expect during the recovery phase, but we have a less dramatic increase than we did in the 1990s, which seems appropriate given the headwinds that the economy faces at the moment. However, I would be the first person to say that if we look at this chart in nine months, the numbers may look different again. We have to address the evidence as it comes in.
Q18 Stewart Hosie: Without stating the obvious that we do not have the erosion of capital assets that we had in the previous two recessions to replace, which may explain some of that, but we will park that just now, I have one final question.
Robert Chote: The decline in investment was pretty similar in the last recession to this one, so you had about a 14% to 15% real decline in the period running up to this 40% to 50% increase.
Q19 Stewart Hosie: Indeed, but there was the requirement to replace physical assets that had been completely eroded in previous recessions, which we have not seen this time. However, that is by the bye. I have one final question. On the main components of GDP growth-it is in the Budget Red Book-the business investment component running through that is the highest single component in most years of GDP growth. Of course, we have general Government consumption down almost across the piece. If this business investment growth is not what is forecast and if outturn ends up being as low as we have seen in the last couple of years, the Government cannot meet their fiscal targets, can they?
Robert Chote: Do you mean if growth overall is weaker?
Stewart Hosie: Business investment growth.
Robert Chote: You have to be slightly careful, because, for one thing, business investment growth, relative to other categories of GDP, is not as positive for the public finances. Ironically, when you revise down your business investment forecast, you have less use of capital allowances, and that is actually positive for corporation tax over this sort of horizon. You can argue that the implications in terms of the longer term strength of the economy and the desirability of investment would outweigh that, but if you actually look at the impact of changes in investment directly on the tax revenue forecast, it is not as straightforward as that. In terms of the overall contributions, clearly, the impact that a weaker growth performance has on whether you hit the fiscal targets depends to a considerable degree on whether that is telling you something about the structural fiscal position or about the cyclical fiscal position. Whichever of those it is, it does not help you get debt to GDP ratios down in 2015-16. If you have weaker growth that is pretty much entirely cyclical, that does not necessarily put you too far off course on the mandate, whereas if there is more structural bad news there, that would have a greater impact.
Q20 Stewart Hosie: So we could have a miserable and sluggish long-term recovery and the Chancellor can still say that he has met his targets?
Graham Parker: He could say that he has met the fiscal mandate. Whether he meets the secondary target of debt falling is another matter.
Q21 Andrea Leadsom: You refer to the inevitable downside risk, yet your core forecasts assume that those disasters don’t happen. Specifically, I believe you used the OECD’s model for a disaster in the eurozone: you took a definition of the disorderly breakdown of the euro, which would involve one sovereign leaving. Will you talk to us a bit about that? Why did you decide that that was a suitable definition of the potential downside? Were there other options that you considered?
Robert Chote: When we discussed this before, we made the point, also made by the Governor of the Bank of England, that there are so many different ways in which what you might describe as unpalatable outcomes for the eurozone could evolve that it is impossible to come up with a probability distribution of likely outcomes containing all the various narratives that might lead you to different outcomes. We were conscious of not wanting to pick out a particular scenario or novelisation that we had managed to come up with that we think would represent all possible difficult outcomes for the eurozone.
Q22 Andrea Leadsom: But did you look at what you three considered was the most likely plausible outcome? Mr Nickell, what do you consider is the most likely disaster scenario, if disaster befalls the eurozone?
Steve Nickell: By the most likely disaster scenario, you mean: if there is to be a disaster, what is the most likely disaster?
Q23 Andrea Leadsom: Correct. Yes.
Steve Nickell: I have not really thought very hard about that. Specifying the kind of disaster and ranking them in terms of probability, is not something we have devoted a great deal of time to. The main reason for that is that we are particularly concerned with what happens to the public finances if there is a disaster. A thoroughly representative disaster of the kind that the OECD constructed serves that purpose very well. It shows that it is, on balance, very detrimental for the public finances, to the extent that the mandate would be broken, missed. That, I think, was our main concern.
Q24 Andrea Leadsom: Do you not think that it would be right to look at this? Obviously, you are forecasting and always caveat everything you say with, "This is just an opinion and we are always wrong. You can count on us being wrong." Surely it would be relevant to say, "In our opinion, the most likely scenario is", for example, Greece deciding to default, or it might be Germany deciding to leave the euro and let everyone else get on with it.
You must have a view between yourselves which is the most likely outcome, if something major were to go wrong. It is important because, of course, in the past couple of years we have seen very significantly increased risk of a disaster. Surely it is not just an outlier; it is not just a once in a billion likelihood. It is something rather more real than that.
Steve Nickell: Frankly, it doesn’t much matter what happens, to the extent that almost any form of disaster will lead to a severe credit crunch. Precisely how the thing pans out is not really that important. The fact is that, however it pans out, if there is a disaster, it will impact very severely and badly on the UK banking system, and, thereby, because of the resulting credit crunch, on the UK economy.
Q25 Andrea Leadsom: So, for example, are you saying that Greece leaving the euro would have the same negative impact as an enormous oil spike or Chinese growth falling off a cliff? Would you extend that analogy to say that any disaster would have the same impact, or just a eurozone disaster?
Steve Nickell: The eurozone disaster has an especially severe impact on the banking system of the eurozone, whereas an oil price spike, which we have in another scenario, does not have such a detrimental impact on the banking system of the eurozone. That is the key. A eurozone disaster has one of its main impacts on the UK because of its effect on the banking system, so we get a repetition of what we had in 2008, but from another direction.
Robert Chote: So much depends in all these scenarios, again, on the extent to which the impact of the crisis on the UK manifests itself in a further structural deterioration of the sort that we have seen over the course of the last crisis. That is why, as Steve says, one would be particularly worried about the sort of crisis that led to severe difficulties in terms of the credit crunch-which, at the moment, is the best explanation we have for why the path of potential GDP seems to have moved so much off the previous, pre-crisis path-versus other sorts of crises that show up as a temporary hit to demand, movements in exchange rates or a change in Government bond yields, for example. One useful thing that the OECD study-we picked that because it was the most comprehensive, recent one carried out by an internationally reputable organisation-highlights is the fact that if this leads to a qualitative set of problems similar to those in the previous crisis, given that that has manifested itself in a structural deterioration, that is one reason why you might be worried about a repetition.
Q26 Andrea Leadsom: Have you looked at the impact of the LTRO programme on the likelihood of a future eurozone shock in the medium rather than the short term? Clearly, in the short term it has had a beneficial impact, but have you looked further to see whether it increases the likelihood of a shock in the medium term? In other words, how likely is a shock to happen and then impact on your forecast, bearing in mind that it is all stargazing anyway, to a certain extent? Should you factor in the potential for that downside and try to think about what it might look like because it is not such an unlikely outcome? Specifically, what change has the LTRO programme made to the medium-term outcome for a eurozone shock?
Steve Nickell: We have not specifically investigated the impact of the LTRO on medium-term dangers. Our main forecast is what we consider to be the most likely outcome. In these sorts of scenarios, we look at possible alternative outcomes that we think of as being less likely. We don’t attach probabilities to them. About 15 months ago, you asked me about the probability of a collapse of the eurozone in the following year. I said, "1.7%"; I think that the probability of this kind of OECD stylised outcome is higher than that now.
Q27 Andrea Leadsom: What date?
Steve Nickell: Occasionally, I go and look at William Hill, which has the odds on these sorts of things. The last time I looked, I think the odds on Greece not using the euro by the end of year were of the order of 40%-a bit lower than they were earlier, after the latest Greek bail-out talks and "success".
Q28 Andrea Leadsom: Are you saying that we should use the OBR and William Hill when checking the forecasts?
Steve Nickell: William Hill gives you a good indication of the average view from people who are thinking about these things and putting their money where their mouth is.
Q29 Andrea Leadsom: Absolutely. I have one last question. You have only really looked at the OECD’s assessment of a likely eurozone disaster and an oil price spike. Did you consider looking at any other scenarios? Specifically, as you might know, the Treasury Committee had a trip to China recently, and it certainly struck me that there had to be an enormous downside risk to China’s having abolished boom and bust-I suspect that they have not done so any more than we have. Did you look, for example, at what would happen if China’s economic boom stopped, or at any other potential disaster scenarios?
Robert Chote: No, we have not looked at that. When we were thinking about the range of scenarios, it is obviously driven in part by what people are expressing concerns about, and the eurozone-
Q30 Andrea Leadsom: So groupthink then-only look at the risks that everyone is talking about.
Robert Chote: No, we are responsive to our stakeholders. Those are clearly the two main ones on which people would say, "These are the obvious things to be looking at".
China is an interesting issue-we haven’t looked at that. There is a question about whether that would be likely to manifest itself primarily as a demand shock, or whether it would simply show up as a greater weakness in terms of demand for UK exports, or a source for imports, and so on. Obviously, a broader global realignment or exchange rate changes could have a much more complicated story, but it is not something we have looked at specifically. The question is whether it would be something that went beyond a demand-shock story that merited looking at.
Q31 Chair: Just to be clear, Mr Nickell, since you are not attaching probability functions to these scenarios, you are saying that we may as well use William Hill.
Steve Nickell: You can use William Hill for finding out what the world thinks about the probability of certain sorts of events-yes, absolutely. It is a good method of finding out the average of people’s views about probabilities of future events.
Q32 Chair: It certainly tells you what the groupthink is.
Steve Nickell: Well, not necessarily, because it could be an average of an extremely dispersed distribution.
Chair: It gives you an average of the groupthink-I think you’ll find it does.
Q33 Mark Garnier: Robert Chote, to what extent do you think that a continued lack of bank lending will be a constraint on economic growth, and how have you factored that into your figures?
Robert Chote: The fact that it still takes some time for credit conditions to normalise is one of the key factors that explains why you have a relatively slow recovery, but it is also one thing that we have factored into deciding when the growth rate of potential GDP is likely to get back to its long-term trend growth rate.
As we discussed when we met you after the last forecast, one of the judgments we took then was to assume that potential GDP growth would not snap straight back to its long-term average, but rather that it would come back over a couple of years, as credit conditions normalised. When we were talking about risks a moment ago, clearly one of the possibilities-that that process gets delayed-would be an important risk to the outlook for recovery, not just in terms of the actual path of GDP, but in terms of your expectations that potential GDP growth or productivity growth gets back to its long-term rate sooner or later.
Q34 Mark Garnier: You talk about normalising, but what do you mean by normal? Do you take 2006, 2007-prior to the crisis-as being normal, or does normal go back to, say, 1999?
Robert Chote: No, you would assume that the period immediately prior to the crisis was not normal, so you are going back to a situation where credit is not as available as it was in the heat of the pre-crisis period.
Q35 Mark Garnier: So when you look at long-term credit in terms of lending margins over the bank base rates, are you-when making your very long-term forecasts-going back to a certain period when that was deemed normal? How are you deciding how the interest rate premiums over the base rate will be determined?
Robert Chote: I think we’re looking back, not to the immediate pre-crisis period, but to what would be familiar in the earlier period of the upswing.
Q36 Mark Garnier: So, still part of the upswing?
Robert Chote: Well, not going right back to the previous recession, for example. Clearly, an important difficulty-not just for these sorts of fiscal forecasts, but generally-is thinking what the new normal is likely to look like. That is further complicated, for example, by regulatory changes and what impact you think Vickers or the like might have in the long term on what the new normal is. I would be wary about saying there is a particular year in one’s mind.
Q37 Mark Garnier: I will come to that in a minute, but do you think businesses have modified their expectations of what they can get from their banks in terms of credit?
Robert Chote: I am sure they have. You have both a demand-for-credit story and a supply-of-credit story, and there is a bit of both going on. On the demand side, obviously that is partly reflecting people’s hopes for the recovery as a whole, and-
Q38 Mark Garnier: And the same applies to households as well, in terms of getting mortgages?
Robert Chote: Yes.
While we are still on the business side, the other distinction is for those companies that are able to access capital markets, as distinct from relying on banks. There is a somewhat different story there. Households have a similar adjustment to make, and clearly we have activity. For example, turnover in the housing market is taking quite some time to return to the long-term levels applied by what you might think of as an equilibrium number of years people typically stay in a house before they move. On current transaction levels, that is clearly very wide, so you have a gradual process of transactions getting back to what you might think of as the previous trend level.
Q39 Mark Garnier: And that is how you factor it into your forecast? You work it in gently.
Robert Chote: Yes, that is right. We have to make some sort of assumption on the transaction side, which obviously matters for things such as stamp duty revenues, as to how quickly you believe that it is reasonable. I think that we have a graph somewhere showing that it is recovering, which I might find in a second, but we basically have it going back to-
Q40 Mark Garnier: While you are looking that up, can I turn to Steve Nickell? Perhaps we can talk about the FPC and its effects in terms of your forecasting. Clearly, the FPC will have macro-prudential tools; I think that it published them this weekend. How will you factor that into your forecasts when you have no experience of how they will operate?
Steve Nickell: Gosh. The FPC has just published some discussion about what its macro-prudential tools might be. It was talking about the standard raising capital requirements, which it thought would be a relatively acceptable thing to do, and then there was the discussion about regulations on loan-to-value or loan-to-income ratios on loans. It seemed to be rather more anxious about whether that would be acceptable.
I am trying to look forward into the future. In our current forecast, we do not have such a growth in credit that we feel that the new Committee will be intervening any time soon. I suppose that the way one might think about doing it is that if you constructed a forecast-this is ignoring the new Committee-and you discovered in the context of that forecast that you had very rapid rises in house prices and rapid expansions in credit, we would probably say, "Ah, but that will not be allowed to happen", because we suspect that the Committee will intervene to restrict the rate of credit expansion, either by using capital requirements and/or direct regulation of things such as loan-to-value ratios. I can see that that would be how we might proceed on that score.
At the moment, luckily-or not so luckily-our forecast does not have any very rapid credit expansions, or at least not anything comparable with what has been seen in the recent past.
Robert Chote: I think that it will be interesting to see just how clear the FPC is in setting a road map, as it were, of how it would behave if things turned out like that in the future. It would make those sorts of adjustments a lot easier if you were clear about how it was likely to respond, so we will have to wait and see what sort of-
Q41 Mark Garnier: There has been a lot of discussion about this. I am slightly surprised-not necessarily surprised-at your candidness about the fact that you have not given it a huge amount of thought. It could have a very significant impact. For example, there is not only the direct impact of whether you have a huge credit bubble, but if you tighten up credit to mortgages, you are potentially limiting the mobility of your work force around the country. It could have all sorts of knock-on effects, both secondary and tertiary, that we do not necessarily know about. You have a lot of work to do, don’t you think, in terms of looking at this.
Steve Nickell: Yes, but again, as I have said, if the world turns out the way that our forecast says it will, we do not see the Financial Policy Committee intervening in that scenario in any big way.
Q42 Mark Garnier: Essentially, you are saying that at some future point, things will change and at that point when things change, you will factor that in to create that environment, if you think that it is necessary.
Steve Nickell: Obviously, that will develop. What will happen first, with any luck, is that the FPC will put out some document that sets out how it might respond and what it will respond to. If, in our forecasts, those things happen that cause it to respond, we can make the appropriate adjustments. I can see this developing over time. It seems to be relatively clear that the FPC is moving in a relatively leisurely fashion, so there does not seem to be any likelihood that it will do one of its significant interventions any time soon.
Q43 Mark Garnier: One thing that has had significant interventions is the MPC, in terms of quantitative easing. In your report you noted: "Whether the second and third rounds of quantitative easing will provide as much support to the real economy as the first remains a risk to our central forecast." Why do you think that the second and third rounds of QE have been less effective?
Steve Nickell: I guess that it is a function of the fact that having acquired such huge quantity of gilts the first time round, it would have been very much smaller in the second and third tranches. There appears to have been some impact on the interest rate curve further out, but I guess that that is partly because it has been relatively small interventions done relatively slowly-whereas first time round, there was a big intervention done relatively quickly.
Q44 Mark Garnier: One thing that I have noticed on this is that, right at the very beginning-when the first £75 billion and £100 billion came in-the narrative was very much in terms of getting money into the system and getting liquidity. In the most recent discussions that we have had with the MPC in this Committee, it has not been about getting money into the system, but controlling bond yields. It has been a way of intervening on interest rates when you cannot, because of the base rate. Do you think that that is a fair assessment?
Steve Nickell: First time round was about getting money into the system as well, but the impact on interest rates was also important, especially the impact on long-term rates. I still think that they think of long-term rates as an indicator of whether they are having an impact, as well as money supply and numbers.
Q45 Chair: Did you discuss your view of QE with the Bank?
Steve Nickell: I am trying to think back. We have talked about QE.
Q46 Chair: Does the Bank agree with that assessment of the diminished effect of QE in round two?
Robert Chote: We do not have discussions with it of that sort.
Steve Nickell: Probably not.
Robert Chote: When it produced its initial article on the effectiveness of QE, we talked to it as we do in the run-up to most of the forecasts in a general exchange of views. We do not, however, say, "This is what we are going to say. Do you agree with that or not?" That is not the sort of relationship that we have with it.
Q47 Chair: So it has not had an opportunity to say, "We do not agree on this point."
Robert Chote: I have not had any communications from it regarding that. As I say, we are saying here that the risk that it is less effective is one that you have to bear in mind and is one that has been expressed more widely.
Q48 Chair: It is a big issue for the Bank and it is a big issue for you. We should be aware if two important institutions are operating off different views of its effects.
Robert Chote: Yes. As I say, we cite it as a risk and I have not had any communication from it to suggest that it is unhappy with that wording.
Q49 Mr Mudie: I want to ask you a couple of questions on the national loan guarantee scheme. You state, somewhat pessimistically, that it should lead to lower funding costs and some additional net lending. Did you quantify the reduction in funding costs or the additional net lending that might result from the scheme that leads you to qualify them in such pessimistic terms?
Robert Chote: There is the broad issue around to what extent, if this has an effect, it feeds through to additional SME lending-i.e. does it change the balance of lending to SMEs versus other borrowers-and then there is the question of whether it adds to the total volume of lending as a whole. Those are both uncertainties which are reasons to be caveated there.
The view we have taken in this report is that we have looked at the first tranche and the magnitude of that does not seem to be large enough to justify material adjustment to the forecast. Then, looking forward to subsequent tranches, if the spreads move as we expect them to do then, then, as it were, the problem this is designed to address is not quite as serious as it would be.
In a sense, it is more like looking at the future tranches as a potential insurance against the rates that SMEs can borrow deteriorating by more than the improvement in our underlying forecast suggests. So we are not saying that this is a waste of time by any means. We are saying that we would not expect the first tranche to have a material impact but, depending on what happens to the pattern of spreads, that it might do in future.
Q50 Mr Mudie: Robert, that is a very successful two minutes that leaves me no wiser. But you were not supposed to make me wise; you were supposed to make me better informed. You say it should lead to lower funding costs. Is that your view? The simple question was, have you quantified your view of the financial effect?
Robert Chote: Yes. Our expectation is that it would lead to some rebalancing in lending towards SMEs from other borrowers. We are less convinced that it would have a significant impact on overall lending and therefore on the economic forecast.
Q51 Mr Mudie: Yes, but that is specifically not answering the question of whether it will lead to lower funding costs for SMEs. Have you quantified the amount of lower funding costs that the SMEs will be able to see as a result of this £5 billion tranche? Secondly, just to speed it up: you say that you anticipate some additional net lending. Let us just put a target down. Will it take the net lending this coming year over or up to the Merlin target? How successful will it be in terms of cheaper loans to SMEs and additional money to SMEs? You’ve gone through this. You’ve made this statement. Tell us what figures underpin it.
Robert Chote: I have not looked at it in the context of comparisons with the Merlin targets. We believe it will lead to lower funding costs to SMEs. It is not clear, in terms of what we have to draw from this, which is whether it affects the overall level of economic activity, that the additionality, in total, will be sufficient to justify changing the forecast. So on that basis we have not done so.
Q52 Mr Mudie: So it is too small and below the radar for it to affect the business aggregate investment that you were concerned about?
Robert Chote: That is basically the judgment.
Q53 Mr Mudie: If they put the full amount in-£20 billion-would that come on to your radar?
Robert Chote: I think that the way the tranching is supposed to be working depends on how spreads are evolving as you go forward-
Q54 Mr Mudie: Okay. Let me put that question a different way. What level of tranche would have been sufficient to make it interesting for your business aggregate investment?
Robert Chote: You mean if they had done it all upfront?
Q55 Mr Mudie: No. Steven, do you want to respond?
Steve Nickell: If they did £20 billion upfront, immediately, then we would have to sit down and think seriously about the additionality there. With £5 billion, you do not have to think very hard about the additionality, because £5 billion is just not very big. With £20 billion, we would have had to think very seriously about how much additionality there was. We looked at the additionality issue, and our general feeling was that it was not very great. In other words, the actual increase in lending you get-the bang for your buck-is not very great.
Q56 Mr Mudie: Just a last question, and you can just say, "No, that was not in my brief". The initial approach, when you read the scheme, is that it is hard to see why it will not merely lead to some SMEs getting a lower rate, rather than boosting additional lending. Did you give that any thought?
Robert Chote: The Government are in part trying to do this, presumably, to help SMEs specifically, and then as a contribution maybe as well to aggregate levels of business investment. There is the broader question of whether that also substitutes for lending to non-businesses. It is for them to decide what their success criteria are for this policy. They might be happy if it is showing up as an SME effect, because they are particularly interested in helping SMEs, and there is an offsetting effect elsewhere. We would argue that the likelihood of that is greater than the likelihood of its making a significant boost to aggregate lending and therefore to aggregate activity in the economy.
Q57 Chair: Actually, they briefed the press and did not deny when challenged that it probably would not lead to net new lending, but they argued that it would make existing lending cheaper and, therefore, would be of benefit to existing potential borrowers. Did you ask the Government about that?
Robert Chote: Not that issue specifically. When we were looking at the aggregate effect, that was the view that we reached.
Q58 Chair: Since it reduces the cost to banks, logically if they keep their risk appetites at the same level there will be more lending.
Robert Chote: To SMEs-yes.
Q59 Chair: Therefore, I am wondering where you got the assessment, Mr Nickell, that there would not be much.
Steve Nickell: Because we are not talking very big numbers here.
Q60 Chair: So you are saying that a large proportion of this might come through as new lending, but that because the sum is small, the overall impact is small.
Steve Nickell: Well, that, and also-
Chair: Is that correct? Are you saying yes to what I have just said?
Steve Nickell: I am saying "Yes, but", if you don’t mind. We are talking one percentage point here. An SME line from a bank is often 8%, 9% or 10%, and one percentage point is not huge.
Q61 Michael Fallon: May we come back to business investment? In paragraph 3.64, you say: "Further assessment" of the official data "suggests that firms’ cash balances may not be able to support as much investment as we previously thought." What is that further assessment? What were those findings?
Robert Chote: It is basically looking at how the way in which the ONS attributes the money that UK companies have on deposit with overseas financial institutions has changed, and whether that is correctly capturing the sorts of firms that are holding those financial deposits-whether it is the sorts of firms that are likely to use them for capital investment, or whether it will be other sorts of firms as well. The ONS is using a Bank for International Settlements survey, which records the claims of UK bodies on those foreign financial institutions. It attributes about 80% of those to the UK corporate sector that you might anticipate would be likely to invest them. Our concern is that a smaller proportion of that than 80% may be with the sorts of companies that are likely to invest this in capital. More of it, for example, might be held in by hedge funds and therefore it is less likely to be used for capital investment. That 80:20 split was come up with quite some time ago, since when the growth of non-bank financial institutions has been rather great. That concern is what primarily underlies the view that the apparent cash piles that lots of companies are sitting on may not be, as it were, just waiting to go out and be invested in capital investments, as the official statistics might suggest.
Q62 Michael Fallon: So you are not saying that the official statistics are wrong about this, but you are saying that, looking into these totals, a lower proportion might be available for investment than somebody else might have thought?
Robert Chote: Yes, the ONS is basically using this Bank of International Settlements data in an attempt to assess the proportion of this that lies with industrial and commercial companies. Our view is that that was a judgment taken some time ago. Given what has gone on in non-bank financial institutions, there might be less of that money available to invest than the data suggest, but it is a very difficult judgment for them to have to make.
Q63 Michael Fallon: Sure. I am just trying to pin down what the dispute is between you and the ONS. You think that they have overestimated the size of industrial and corporate lending inside that pot?
Robert Chote: The proportion of money held on deposit with overseas financial institutions-that is, in the hands of companies that might go out and use it for capital investment-yes.
Q64 Michael Fallon: So that is nothing to do with the current situation.
Robert Chote: No.
Steve Nickell: No.
Q65 Michael Fallon: It is just how the way they do it is interpreted?
Steve Nickell: Yes, exactly.
Q66 Michael Fallon: You were quoted on Budget day, or before, in the Financial Times as saying: "The recovery in business investment is somewhat weaker this time around than after the recession in the 1990s." Could you clarify how that fits with paragraph 3.63, in which you say that you "expect strong medium-term investment growth…repeating the pattern of the 1990s recovery"? I just want to be clear about what is different from the 1990s.
Robert Chote: It’s repeating in the sense that it is strong; it’s not repeating in that it is not quite as strong. Chart 3.15 basically shows you that. The chart shows the year-on-year changes in business investment for the four years of the downturn and the first five years of the recovery. The common pattern is that, for a start, you have a similar average decline in the years of the downturn, and it is common then to see a big rebound thereafter, a rebound that is large enough to see business investment rising as a share of GDP and, therefore, helping to pull up overall GDP growth. But, as you see, we have a slightly lower average growth rate for business investment over those five years than we had in the equivalent five years of the ’90s. So that is what is the same, and that is what is different.
Q67 Michael Fallon: So that justifies the phrase "somewhat weaker"?
Robert Chote: Yes.
Q68 Michael Fallon: Okay. Do the changes to the forecast for business investment suggest that rebalancing the economy away from consumption is going to be much harder than we originally thought?
Robert Chote: If you define it as investment and consumption as a share of GDP, we have a smaller increase in investment as a share of GDP and a slightly stronger consumer spending forecast. In that sense, there is less rebalancing going on. Whether the Government regard that as being too much or too little rebalancing is a matter for them.
Q69 Mr Love: To what extent do the measures in this Budget affect or impact on your growth projections?
Robert Chote: Not a great deal. The aggregate Budget judgment over the five years of the forecast is pretty neutral. The net balance of takeaways and giveaways is no larger than £2 billion in any given year, so we are talking barely 0.1% or 0.2% of GDP. In that sense, there is no great net addition to or subtraction from aggregate spending in the economy as a result of the Budget measures. What we have done is note that there are a couple of measures in which you want to pick out a specific effect, such as the broadening of the VAT base and the decision to increase tobacco duty more than was previously implied has a direct impact on an inflation forecast, and we have taken that into account-and the specifics of the reduction of corporation tax. That reduction has a modest offsetting effect on the downward revision in the business investment forecast to which Mr Fallon referred, but it is small in comparison with the overall reduction in the business investment forecast since last time.
Q70 Mr Love: In fact, it is very small. In business investment, you are suggesting 1% over the term to 2015 and for GDP you are suggesting 0.1%.
Robert Chote: That’s right. So, you would expect the level of business investment to be 1% higher at the end of the forecast as a result of the change in the corporation tax rate and the consequences that has for costs for capital. That is a metric that has been used in previous forecasts. There is no new view about the potential impact of this.
Q71 Mr Love: Will the benefit of that reduction in corporation tax be sufficient to offset the cost of the measure itself?
Robert Chote: I do not think there is any argument about it being self-financing in that sense. If you were to increase GDP by 0.1% at that level then the equivalent amount of that is not offsetting.
Graham Parker: As we said earlier, the increase in investment actually reduces corporation tax. With capital allowances the immediate effect is to reduce corporation tax.
Q72 Mr Love: The Chancellor has made great play of the need to attract foreign investment, and the rate of corporation tax is very important in achieving that. Yet, after this measure is introduced, as I understand it, we will be fifth lowest in the G20. The others, who are lower than us, are not exactly our biggest competitors. Isn’t there a declining benefit from continuing to reduce corporation tax in terms of what the Chancellor is trying to achieve?
Robert Chote: There presumably is an issue there. Partly, if you are thinking about a pool of globally mobile profits that you are trying to attract more to the UK by having a rate that is lower relative to other countries, that will obviously be affected by what the rates are doing in other countries and by other features of the tax system: the tax base as well as the particular rates that are imposed. The mechanical effect referred to is not based on where we are in a league table. It is more about the cost of capital and the likely impact that would have on capital investment.
Q73 Mr Love: Well, not according to the Chancellor who makes great play of this. I am pleased you answered in that way. There have been a number of questions in relation to bank lending. Is the lack of bank lending, in your view, a constraint on growth in the economy?
Robert Chote: Yes. It is one of the reasons, as I said, why we have not only growth taking some time to respond but also potential GDP growth to get back to normal. That is partly the fact that credit conditions have some way to go to normalise.
Q74 Mr Love: Yet we have already heard that the national loan guarantee scheme is unlikely to have any impact on new net lending. If you take it as £5 billion, you said that was too small to have an impact. Yet, by the time they build up to the £20 billion, it is likely that growth will have increased and the difficulties in financial markets will, hopefully, have resolved themselves. Therefore, the benefit of this measure tails off into the future. So, it is irrelevant to considerations of growth in the economy.
Robert Chote: Not necessarily. If the spread story is not as good as the central forecast suggests, the future tranches are more valuable and more growth effective than they would be if things improve on the path that we are suggesting here.
Q75 Mr Love: I understand that, but on your central projection-
Robert Chote: On the central projection, the spreads improve sufficiently that this would not have-as I said, we haven’t adjusted the forecast in the future to take account of that, on the grounds that if the spreads improve, as we suggest, that will be less necessary.
Q76 Mr Love: A drop in corporation tax has had little impact on overall growth. We know that bank lending continues to be a problem, yet the national loan guarantee scheme-. Are we down to just waiting until growth returns to the economy, according to your projections, in 2014, before we get back to the norm?
Robert Chote: As I said, we do still have investment contributing, pulling the growth rate up. It remains a driver. You have investment rising as a share of GDP. As we were discussing with Mr Fallon, it is rising strongly but not as strongly as in the previous recovery.
Q77 Teresa Pearce: I want to talk to you a little bit about tax rates and the 50p tax rate. I believe that your analysis was based on the work done by HMRC. When did you get that analysis from HMRC?
Robert Chote: I do not know when we first saw drafts of it, but we had been discussing with them for some weeks before we knew what the Government were going to assume in terms of the responsiveness of taxpayers to the tax measures.
Q78 Teresa Pearce: So you have had some ongoing discussions with them. Did they give you access to the underlying data?
Robert Chote: Not to the underlying data. For reasons of taxpayer confidentiality, you do not see that material anyway. We obviously get a sense of where-this was especially the case with the self-assessment data-
Q79 Teresa Pearce: On self-assessment data, they would not have had 100% of those 300,000 tax returns. Do you know what percentage of those returns they would have been basing their figures on?
Graham Parker: It is in their documents somewhere.
Robert Chote: I think 90%, but I might be wrong.
Q80 Teresa Pearce: It is quite surprising that they have had a chance to analyse nearly all the self-assessment returns given the backlog in their work. They have obviously pulled them out as a priority, because they need to do this piece of work. For the reasons that you said, you did not have access to the underlying data, so what did you do to interrogate the figures?
Robert Chote: One thing is to look at their consistency with the first set of outturn data that were coming in. In the January public finance data, which we comment on publicly, you were already seeing some evidence of self-assessment receipts coming in weaker than we had anticipated at the time of the November forecast. In that sense, it was not counter-intuitive given the aggregate figures there. There was certainly then a question in our minds about to whether the subsequent February data were likely to come up with the same sort of picture. As they came in, that was clearer.
Q81 Teresa Pearce: Are you saying that the figures that they gave you tied in with what you expected, or are you saying that there was no interrogation of their figures?
Graham Parker: There was quite a bit of interrogation. We particularly asked them to ensure that what they were saying in this analysis actually was consistent with the receipts information that we were getting. There was a breakdown of the different types of income, which underlies the self-assessment. The concentration was on the self-assessment returns. We asked them to ensure that what they were saying about forestalling and behaviour was consistent with what we had seen in the receipts. We were very concerned about the effect on the receipts forecast of what they were saying, so we asked them quite a lot of questions on that.
Q82 Teresa Pearce: When you were briefly surprised by the level of receipts, because it was less than you expected, why didn’t you challenge the estimate of the 50p tax before you did?
Graham Parker: We were not actually surprised. We did not actually know about the full extent of how bad the self-assessment was until the middle of February.
Q83 Teresa Pearce: You expected the receipts to be higher.
Graham Parker: Yes. Our forecasts in November were that self-assessment receipts would be about £3.5 billion higher than they actually were. It was not until halfway through February that we knew the complete scale of the shortfall. That is when we started asking them questions.
Q84 Teresa Pearce: So is the scale of the shortfall because of a lowering of income or a lowering of returns or income shifting? Do you know why?
Graham Parker: It is a bit of both. Well, a bit of everything. We have got a table. This is very complicated. In particular, self-employment income was quite a bit lower than expected. You also have to try to get the forestalling and people who brought forward their income.
Q85 Teresa Pearce: I have some concerns about forestalling. I used to work for PwC in tax investigation, so it came as no surprise to me whatsoever that people shifted their income, but it seemed to be a surprise to everybody else. Looking at some of the figures, it is estimated that £16 billion of income was shifted then, but what is obviously going to happen is that people are going to shift again, but the other way. Yet you have estimated only £6.25 billion for that, which seems quite low to me.
One of the things that happened with the shifting-obviously, the Government brought in the 50% and then there was going to be an election-was that a lot of people thought, "Well, with the election of a new Government this will all be reversed, so maybe it is not worth doing." The fact that, when a tranche of people thought the 50% would be only very temporary, £16 billion was shifted makes £6.25 billion seem quite a low estimate of what people will shift the other way.
Robert Chote: One issue is obviously that the differential in the tax rates is half of what it previously was.
Q86 Teresa Pearce: Half of quite a lot is still quite a lot.
Robert Chote: It is quite a lot. The other point is that in the case of avoiding the 50p rate, there were several years in the future that you could shift the income out of into the year prior to the rate change happening. In this case, you have only this year to shift it out of into the future year in order to take advantage of the lower rate, so there is a smaller pool of time period to shift your income out of.
Q87 Teresa Pearce: Even so, in your estimate, it looks as though in 2012-13 there will be a £3 billion drop in revenue, because of people shifting the income.
Robert Chote: That is right. Roughly, if you have £6 billion, that is the impact.
Q88 Teresa Pearce: That is a big number, and the assumption is that it will come in the later year.
Robert Chote: As I say, you are looking there specifically at the forestalling effect-the simple time shifting. There is then the separate issue of what has been the underlying behavioural response that you might expect to persist as a result of labour supply responses or of permanent changes to tax planning behaviour and so on. It is a heroic exercise to try to disentangle those two components and to quantify them.
Q89 Teresa Pearce: Do your forecasts assume a top rate of 45% throughout the spending review period?
Robert Chote: Yes. Until the Government announce that they are going to do anything different in the future, we take current policy.
Q90 Teresa Pearce: Have you been asked to do any estimates of a lower rate of 40% for the top rate?
Robert Chote: No we have not, but in an attempt to explain the costings that we have signed off in terms of the 45%, we have had reference to the way in which the revenue is likely to respond, so in fact we have an estimate that the cost of shifting from 50% to 40% is about £700 million-if memory serves me right-in comparison with shifting from 50% to 45%, which is about £100 million.
Q91 Teresa Pearce: This is not about income tax but corporation tax, but it picks up on what you said earlier. Looking at your figures, the figure that you claim will be lost in corporation tax because of the lowering of the rate seems really low: it is something like £400 million. This year, corporation tax receipts have been £42 billion, so a reduction of a couple of per cent would be a bigger figure than that, I would have thought. Have you got other things in that figure? Maybe you cannot tell me now, but perhaps you could write to me.
Robert Chote: There is a behavioural response.
Q92 Teresa Pearce: On corporation tax-I think the table is on page 180.
Robert Chote: If you look at this, it will break down the behavioural and the non-behavioural change, and that will get you to that number-if I can find it.
Q93 Teresa Pearce: What you are saying is that you are gambling on behaviour.
Robert Chote: We are not gambling on behaviour. If you have been at PwC, you know you have to think about how people respond to financial incentives in terms of the way they behave as regards that.
Graham Parker: But if CT is £42 billion, a 1% cut is about £400 million.
Q94 Teresa Pearce: It is a 2% cut, isn’t it?
Graham Parker: No, we are costing only a 1% cut in this Budget-the other one had already been announced.
Robert Chote: The first 1% had already been announced, so we are costing only the 1% additional change.
Q95 Teresa Pearce: Does that include the behavioural as well?
Graham Parker: I do not think there is that much behavioural, is there? There is a bit. The theory is that these mobile profits are more likely to come to be in the UK rather than elsewhere, as we were talking about earlier.
Robert Chote: There is not a huge behavioural change. It makes about £200 million of difference at the end of the forecast period.
Q96 Teresa Pearce: Based on the figures that you have done and all the calculations, how much would the 50% tax have raised on an annual basis had it stayed?
Robert Chote: Rather than the £2.7 billion that it was estimated to raise in the March 2010 Budget, we would be looking at something between £700 million and £1 billion and a bit, depending on how you did the calculations, so it is about a third of the original estimate.
Q97 Teresa Pearce: Given that this group of people-these 300,000 people-shifted income in 2009 and are likely to shift income again, and they have these behaviours where they try and pay as little tax as possible, do you think rewarding them in this way is correct?
Graham Parker: That is not a question for us.
Robert Chote: It is for the Government to decide what their objectives are and change these things. One point to bear in mind, obviously, is that the scale of the behavioural response is not laid down by holy writ. Policy choices can affect the amount that you raise from these sorts of things. For example, the structure of the tax system will help determine the scope for avoidance. You can make changes that might affect the expected level of that.
Q98 Teresa Pearce: Given that we know, or you think you know, that £3.4 billion is going to be shifted, perhaps that is something that we should look at and plug that gap so that income shifting is not so easy.
Robert Chote: I would make a distinction. If you announce a tax change like this-the same was true when it went up to 50p in the first place-and if you do not do it immediately, you are obviously creating a one-off opportunity for people to shift-
Teresa Pearce: A window.
Robert Chote: Exactly, a window. I would distinguish that, which is hard to predict, with the also very hard to predict judgment of how will more long-lasting behaviour change in terms of concrete labour supply responses-do people work less, retire at a different time, leave the country-and do they tax-plan, tax-avoid or tax-evade more or less than they otherwise would? So you have those two effects. Obviously, when you have a change that has both of them going on at once, that is one of the things that has made HMRC’s job so difficult-to try to disentangle those two things.
But in terms of thinking about the impact of the policy, you need to distinguish between the facts. By announcing a change that does not come into effect immediately, you have one set of behavioural responses that are a one-off, and then you have longer-term ones that, presumably, are more fundamentally about what the policy is aimed at in the longer term.
Q99 Jesse Norman: A quick question before the main one. Have you looked at any of the academic literature on prediction markets?
Robert Chote: Not recently, no.
Q100 Jesse Norman: I just wonder whether it might be a helpful adjunct to what you are doing in terms of thinking about predictions of the William Hill kind that we have been talking about. It is not a completely daft idea. They actually have quite a good record in some respects.
Steve Nickell: The answer is yes. I have looked at this. They are very good on predicting the results of elections-much better than surveys.
Q101 Jesse Norman: I wondered whether it was a new frontier for the OBR. On the Budget, it is interesting that in your book you have a couple of pages on monetary policy, which is arguably the biggest single influence at the moment on growth. Have you looked at the risks and benefit from unwinding quantitative easing?
Robert Chote: No, we have not. We basically take the market expectations of future rates in which, implicitly, you might assume that underpinning those is some view of how the Bank of England is likely to unwind this. There is not a policy out there for us to be able to incorporate in any specific way on that score yet.
As I understand it, the plan is that once monetary policy is back on a tightening path, they would intend to gradually reverse it. I presume that that expectation is in the price as far as the expectations of policy rates are concerned. It is not for us to predict or to say that the Bank ought to do it this way or that way.
Q102 Jesse Norman: No, except that there may be some risks involved, which, since we are in uncharted territory, are probably worth thinking about. Of course, the original point of QE was to provide credit support to industry, rather than to the Government. That is still in the instructions that the Bank has been given. From that perspective, do you think that it has been a well designed policy?
Robert Chote: The policy has clearly been designed-
Chair: You can speak frankly among friends. [Laughter.]
Robert Chote: The aim has been to do this through its impact on gilt yields and therefore the impact that that will have on other market rates. I know that there has been a lively debate as to whether this could have been done in a way that affected corporate borrowers more directly, but that is an issue for the Government and the Bank, not for us.
Q103 Jesse Norman: It is a question that I would be grateful if you could return to in your writing, particularly since other central banks seem to take different approaches and have more direct means of support to corporate sectors.
The final, very quick question returns to the question that has been sitting around for a while. If you look at these big-balance-sheet types of recessions and recoveries-one might be thinking of Sweden, Canada and Japan-it looks like it is six to 10 years; it is that scale of thing. We seem to be in a situation where large amounts of additional borrowing over and above the stabilisers may themselves have a depressive effect on growth. Do you think that there is much growth around at the moment? Are there things that the Chancellor could have done that would have had a sustainable increase in growth, on either side of the equation-either by reducing the fiscal impact or by increasing it?
Robert Chote: You, by whom I mean Parliament, have instructed us not to look to alternative policy paths, in the legislation that set us up, so I cannot go too far.
Q104 Jesse Norman: You do not need to comment on policy. Is there growth available? That is what I want to know. The evidence historically is that there would not be at this stage in the recovery.
Robert Chote: We have a central forecast that shows a steady recovery, one weaker than previous recoveries-weaker than the last three, certainly. Given what you have in terms of credit conditions taking time to normalise, balance sheet adjustments and fiscal consolidation, that does not seem unreasonable.
Q105 Jesse Norman: You are bringing this in a six-year level rather than a 10-year level.
Robert Chote: I forget now where our latest forecast suggests we return to the peak; if I made it up, I would get it wrong. Clearly, we are talking about, as I say, a weaker recovery on that basis.
In terms of the debate over what more could be done-as I say, it is not for us to get into the merits of plan A versus plan B-I would point out that we may have taken a view that there might be less potential out there than we previously thought, and that brings us into line with people such as the OECD and the IMF. But there is still spare capacity in this economy, and on our forecast, it has not been fully closed at the end of it.
This is not an economy that could not do with a bit more growth if you could get it. There is a perfectly lively debate out there, which we are told not to participate in, as to whether there is a policy change that would deliver that improvement without having counter-productive consequences.
Q106 Chair: We began the discussion about the output gap and the very high level of uncertainty there is with respect to forecasting at the best of times, and certainly at the moment. Would it be a healthy thing for public debate if the press-and the public, for that matter-placed less faith in forecasts?
Robert Chote: In most of the press that I read, I am not sure whether faith in our, or anyone’s, forecasts is widespread.
Q107 Chair: Are you happy to downgrade the importance of your own work?
Robert Chote: I was very clear that this was one of the things-
Q108 Chair: Not the quality; the importance.
Robert Chote: No. What you need to do is set out the uncertainties. A key part of our job is to bolster the transparency of the fiscal forecasting process. That has to be based on economic forecasts, with all the difficulties that that involves. One should not hide away from that. Judgments have to be taken on these things in order to reach a view, as we have been instructed to do, on whether you are more likely than not to hit the target at the end of the day. That is the job that we have been tasked to do.
What we have done-more than was done under the previous regimes-is to set out as clearly as we can what the uncertainties are, to try to quantify those and to say which bits of the uncertainties matter more in terms of outcome for the fiscal position and others.
Q109 Chair: The message from this Committee, among other things, is that we want to see as much as possible about those uncertainties and your assessments of them. I suspect that that is the point that Andrea wants to come in on.
Q110 Andrea Leadsom: Actually, it is a point of process. Would you say that, in coming to your central forecasts, you have all the tools at your disposal that your predecessors would have had? Obviously, you are not part of the Treasury team, by definition. Does that hamper your ability to provide reasonable forecasts?
Robert Chote: I don’t think so. If we have issues that we want to explore with the Treasury, we will go to them and ask whether they would like to share with us any analysis they have on a particular issue. They have been very responsive in doing that.
Q111 Chair: Which brings me to the question that I always ask. Have you had all the co-operation you need and have you any evidence to suggest that any of your team have been put under any pressure that has been inappropriate?
Robert Chote: No, we have not.
Chair: Thank you very much for coming. We have appreciated it.