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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 1691-ii
HOUSE OF COMMONS
TAKEN BEFORE THE
AUTUMN FORECAST 2011
TUESDAY 6 DECEMBER 2011
ROBERT CHOTE, STEVE NICKELL and GRAHAM PARKER
Evidence heard in Public
Questions 117 - 257
USE OF THE TRANSCRIPT
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Taken before the Treasury Committee
on Tuesday 6 December 2011
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr George Mudie
Mr David Ruffley
Examination of Witnesses
Witnesses: Robert Chote, Chairman, Office for Budget Responsibility, Steve Nickell, Member, Office for Budget Responsibility, and Graham Parker, Member, Office for Budget Responsibility.
Q117 Chair: Thank you very much for coming to see us this morning, Robert and the OBR team. Can I begin by asking something which I think that this Committee should always ask you? Have you come under any what you might consider to be untoward pressure to in any way alter this forecast?
Robert Chote: No, none whatsoever, Mr Chairman.
Q118 Chair: You have brought a big audience with you, by the way, so clearly your earlier performances have gone before you.
Could I take you to box 3.1 of your report? In there, you say, "Low credit availability has been particularly acute for small and medium-sized enterprises." What evidence do you have to support that? What evidence base have you used to support that assertion?
Robert Chote: There is a variety of survey evidence. For example, the Bank of England agents reports have been important on that. I think you have seen some evidence as well from the CBI surveys, but the agents have been quite important in saying that. You have a combination of the credit conditions being difficult, but also survey evidence of a reluctance to borrow because of concern about the health of demand in the medium term as well, so there is a demand story there as well as a supply story.
Q119 Chair: You are suggesting that the weak productivity growth may be enduring, aren’t you?
Robert Chote: Yes, I mean-
Q120 Chair: Therefore, to the extent that this is making a contribution to it, this is going to be enduring.
Robert Chote: Yes. To what extent the impact on small and medium-sized enterprises is affecting the overall picture, given the relative size of those to the whole economy, I would not want to place too much weight on that. Clearly, the past performance-
Q121 Chair: Just to be clear, how much weight? If we look at box 3.1, we have a set of reasons for explaining your change of view on output growth, and this is clearly one of the substantial factors that you are taking into account.
Robert Chote: The main thing we are taking into account is to look at the history, and then the aim of this box is to try, very imperfectly, to explain why, if you look at the evidence of the output gap indicators-the cyclical indicators-and the evidence of real GDP, it appears that both productivity growth and potential output growth have been weak since the recession ended. That is turning out to be very hard to explain. Some of the things that are relatively easy to quantify-capital per worker, for example-clearly do not get you very far. I think that, at this stage, the argument that credit conditions may be interfering with the reallocation of capital is perhaps the most persuasive explanation out there, but it is almost by a process of elimination.
Q122 Chair: So you are arguing that it will be enduring, aren’t you?
Robert Chote: Yes. The assumption we have made is not to assume, as we did in our previous forecast, that potential output growth snaps straight back to the long-term average of in excess of 2%. As more evidence has mounted of its remaining relatively weak in the out-turn data, assuming it snaps back does not seem to be a sensible central assumption now. Hence, we have this glide path over a couple of years from current or from recent past evidence of weaker potential output growth to what we assume to be the longer term pattern in a couple of years’ time.
Q123 Chair: Did you look at the agents reports eight months ago, from the Bank?
Robert Chote: I suspect we did at the time. I cannot recall what they were-
Q124 Chair: What is it that has changed so much in the past eight months that has led you so sharply to revise your view of productivity growth and the output gap?
Robert Chote: Well, one of the reasons, as I say, is the fact that you have more evidence that the out-turns for productivity growth and potential output growth have remained relatively weak since the recession ended. One thing you also do there is to look at what others-for example, the IMF and the OECD-have concluded at last, and they are also saying that they think that potential output growth has been growing by 0.8%, 0.9%. The idea, again, of assuming that you jump back to this 2.3% seems less persuasive.
One other factor that you can argue is a dog that did not bark is the Blue Book revisions in the autumn of this year, where I think there had been some hope from a number of quarters that that might help to resolve the productivity puzzle. In the end, it has actually deepened that one-it has helped resolve a couple of other puzzles on the saving ratio and exports-but the idea that that was going to come to the rescue and solve a lot of this puzzle was not there. That was another reason why we felt it was-
Q125 Chair: I still have not got to the bottom of what it is that you were looking at a few weeks ago, which you were not looking at six months ago, that has led you to this sharp change of view.
Robert Chote: As I say, it is the accumulating evidence that since the recession ended, potential output growth has been weaker than we would have anticipated back in March. If you look at how the output gap has changed over the past year, the spare capacity indicators from business surveys and the evidence from earnings growth seem to be suggesting that, if anything, there is less spare capacity than there was a year ago, despite the fact that we have had a very weak performance from economic growth over the same time period. It is that evidence that has built up.
Q126 Michael Fallon: Let us hear from one of your colleagues. Professor Nickell, Roger Bootle told us yesterday that the effect of this forecasting error is that GDP will now be £65 billion lower in 2015 than you said in March. Is that right?
Steve Nickell: I am sure if Roger Bootle said so, it must be true. I have not exactly got that number to hand.
Robert Chote: It is about 3%.
Q127 Michael Fallon: Can we hear from Professor Nickell? You think it is around 3.4%, as he said, by 2015, and 3.5% by 2016?
Steve Nickell: Right. That is the level.
Q128 Michael Fallon: So how did you get this so wrong?
Steve Nickell: As Robert has just explained, what we were expecting back in March was somewhat stronger growth than turned out in the near term, and, despite that, we were expecting the output gap to widen, because that growth, although stronger than turned out, was weaker than historical trend growth.
What happened was that, by the time we looked at these things in November, we found that, while output growth had been very, very modest for the last year, the surveys and the Bank of England agents and so on were telling us that, throughout that year, there had been no widening of the output gap at all. That means that they were not telling us that, despite this well below-trend growth, they had lots more extra capacity, which we would have expected. That was quite a shock to us, and we then thought, "Well, hang on." It has now become impossible to believe that the potential output growth rate of the economy is immediately-as soon as we make our forecast now-going to slip back to the long-term trend, which is what our previous assumption had been. That, I guess, is why you see what you see.
Q129 Michael Fallon: It does sound like a guess though, does it not? You use the word guess. If you look at box 3.1, you say that potential labour supply may have reduced, that capital per worker may have been reduced, that output per worker growth may have slowed, that credit availability may have been impaired, and that the scope for investment may have been reduced. This is just guessing, is it not?
Steve Nickell: Yes, we are running through a list of things. We know exactly what happened to capital per worker. Capital per worker growth, at least up until the data points that we have, has not showed great signs of slowing, whereas we do know that productivity growth has been remarkably modest for an economy coming out of a deep recession. When it says in there "may have done this" or "may have done that", that is an attempt to set out the list of reasons why there has been this change in our view, and we can be fairly certain about some things, such as that the weak productivity growth has not got much to do with a fall in capital per worker or with composition effects. It seems to be the case that the lack of credit availability is impairing the adjustment of the economy, which is continually necessary to generate productivity growth.
Q130 Michael Fallon: Okay. This box shows that you have changed your view. The result of that is a £65 billion difference, but you are not sure why you have changed your view. You set out five vague ideas as to why you may have changed your view, but you are not sure why you have changed your view.
Robert Chote: Well, we have changed the view, as I say, because of the out-turn data. The attempt of the box is to explain why the out-turn data has performed in the way that it has. The decision to change is on the basis of the evidence that has come in. The puzzle is trying to explain why the evidence shows what the evidence does.
Q131 Michael Fallon: Yes, but the point that I am trying to get Professor Nickell to focus on is these explanations-
Steve Nickell: Given the rate of growth of potential output in the last two years, it seemed to us to be inconceivable that it would move rapidly back to its historical trend.
Q132 Michael Fallon: Okay, but if you were so wrong in March, how do we know that you are right now?
Steve Nickell: You don’t.
Robert Chote: You don’t.
Q133 Michael Fallon: So you might be back in six month’s time telling us-
Steve Nickell: We are talking about the future, and no one knows the future.
Robert Chote: We are talking about the future and an unobservable variable on potential output, so I think you know well enough the limitations.
Q134 Michael Fallon: You are being paid to help forecast the future. This is not very good, is it?
Robert Chote: No.
Q135 Chair: Just to be clear, you are saying that, in six months, your view of longer-run productivity growth may be completely different.
Steve Nickell: No, no. It depends what you mean by a long run, but after two or three years we expect potential output growth and trend productivity growth to get back to historical averages.
Q136 Chair: You are sure about that?
Steve Nickell: That is what we expect.
Q137 Chair: I am not asking you to be sure about the future; I am asking you to be sure that that is your view.
Steve Nickell: That is the view incorporated into this forecast.
Q138 Chair: Six months ago you radically changed your view about these long-run variables.
Steve Nickell: No, we didn’t.
Q139 Chair: Well, you have changed your view pretty radically about your estimate of output growth, haven’t you?
Steve Nickell: In the medium run, not in the long run.
Q140 Chair: We are disputing medium and long run.
Steve Nickell: Two years is medium.
Q141 Mr McFadden: The OBR has only been in existence a year and a half. It has not been a very happy start, has it?
Robert Chote: In what respect?
Q142 Mr McFadden: You have had to change all of your main assumptions and forecasts. In a matter of months, your prediction for growth for this very year has changed from 2.6% to 0.9%. For next year-not the distant future-you had forecast growth of 2.8% and it is now 0.7%. We have just heard from Mr Fallon about the gap in GDP between what was being predicted and what is being predicted now as about 3.4%, or £65 billion, and on and on. The OBR was an important innovation in Government economic policy making. These are drastic changes; they are not minimal, they are huge, and they affect this year and next year. If you got it so wrong a matter of months ago, why should anyone believe what you have got to say this time or next time?
Robert Chote: We reach the views we do on each forecast on the basis of the set of available information and evidence that we have at the time. I would in the long term be a lot more worried about our credibility if we engaged in what, with my previous hat on, I used to call conviction forecasting. That is to stick with a particular set of economic predictions long after the supporting evidence has disappeared.
What we have to do is set out on each forecast that we produce the judgments that we have reached as transparently as we can and to explain as candidly and clearly as we can what the uncertainties are around those, and what the implications will be for the fiscal position if some of those key judgments turned out to be different. You have to recognise that the evidence changes, both in terms of the evidence you are dealing with about where things are going in the future, but also what the out-turn, what the past has been.
As an apple-cheeked young reporter on The Independent I turned up to the equivalent of this hearing 18 years ago, after Kenneth Clarke’s first Budget. The official statistics at the time, the last Blue Book, showed that during the course of the 1990s recession, GDP had fallen by 4.3% from peak to trough and ended in a double dip. If we look back at the same numbers now, the decline is 2.5% and there is no double dip. If our forecasts were absolutely bang on the nail now, I would be warning you and myself that the chances of them remaining bang on the nail, as history was revised, were virtually nil.
Q143 Mr McFadden: If everything is so uncertain, what is the point of the OBR?
Robert Chote: The point is that all economic policy has to be set on a forward-looking basis. The fact that it is extremely hard to predict what actual and potential GDP is going to be in five years is certainly true. We have been asked to police a target for a cyclically adjusted measure of the Budget balance in five years’ time, so we have to reach judgments on those things.
The very fact that you have not just a cyclically adjusted target, but the five-year time horizon, necessitates that you take some sort of view about the future path of aggregate demand and aggregate supply in the economy. Just to say that this is very difficult and history changes, therefore let’s not look out of the windscreen when we are driving ahead, I think would be something of a mistake.
Q144 Mr McFadden: Mr Parker, you have not said anything yet. Are you embarrassed by the drastic changes you have had to make?
Graham Parker: Certainly not.
Q145 Mr McFadden: So we could come back, as the Chairman said, in six months’ time and you could have completely changed these numbers again.
Graham Parker: I would not have thought that. What happened this time is that there has been quite a big change in the evidence available. I doubt we will have to make so much of a drastic change through the output gap.
Q146 Mr McFadden: I wasn’t on the Committee in March, but that is what you would have said in March, if the Committee had asked you about your forecasts then, is it not?
Graham Parker: Possibly.
Q147 Mr McFadden: Can I ask you about the long-term trend rate of growth? In paragraph 3.4, you say, "Rather than assuming that the growth of potential output snaps straight back to 2.3 per cent, our estimate of its long-run average, we now assume that it picks up gradually over the next two years as…conditions normalise." There seems to be a pattern to these forecasts. They are constantly downgraded in the short term, but this figure of 2.3%, 2.5% or something thereabouts is always held out as the carrot in a couple of years’ time. From the UK’s point of view, given the extraordinary economic circumstances that the world has gone through in the past few years, why should we assume that it snaps back at all in the medium term?
Robert Chote: If you think about whether the events of the crisis are likely to have changed the very long-term pattern of productivity growth rather than to have caused a temporary downward shift, which has led to the level loss of GDP, it would be hard to identify factors that would explain why the impact of the financial crisis should be affecting what is happening to trend growth over a five to 10-year time horizon, although it is extremely hard to predict what that rate would be. On that basis, the past long-term average is probably as good a guide as we have for what the future long-term position will be.
Q148 Mr McFadden: That is really the basis on which you assume this snapping back-it happened before, so it will happen again.
Robert Chote: The long-term historical path is probably the best guide to the long-term path in the future. In the meantime, we have seen a temporary weakening in trend growth, which means that the projected level path of GDP has been shifted down as a result, which is why we have had the opening up of the structural fiscal difficulties that policy has been addressing over the past-
Q149 Mr McFadden: How seriously do you take the possibility that the damage to the financial system has been so serious and is so ongoing that we will not get back to 2% plus rates of growth for a long time?
Robert Chote: I do not think we would see that the evidence was strong enough to make that judgment about the long term. We see that the damage done seems to be a plausible argument for why you should not expect it to get straight back to that rate over the next couple of years or so as credit conditions and the financial sector, hopefully, normalise. For reaching that long-term judgment, the long-term historical path is probably the best we have to go on.
Q150 Mr McFadden: Finally, can I ask you about the five-year fiscal mandate that you mentioned? Jonathan Portes submitted written evidence and appeared before the Committee yesterday. In his written evidence, he says, "It is important to note that the fiscal mandate-‘to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period’-does not ensure long run sustainability." The Chancellor could keep rolling this forward, which would be consistent with the rule that he has set himself. Jonathan says that even if economic circumstances are entirely unchanged, the Chancellor could delay all tax rises and spending cuts by a year-so, again, running a deficit of, say, 10% of GDP in the first year and reaching balance by the fifth year-and keep rolling this forward. Is the fiscal mandate meaningful if the carrot is always five years ahead?
Robert Chote: You, as in Parliament, have instructed us not to give a public view on the merits or not of the mandate. You have raised two questions: one is whether it guarantees long-term sustainability. Well, it is a five-year time horizon target, so clearly it does not. In our July fiscal sustainability report we examined that question by making projections over a 50-year horizon. It is clear that the success or otherwise of achieving the mandate over the five-year period is outweighed by demographics and other factors over the longer period.
You are right in the sense that, having chosen a rolling mandate, the Government are moving forward the end point at which they are aiming each year. It is for them to decide how much room for manoeuvre there is and how interested they are in the closer years. All we can do is to be as transparent as we can about how the fiscal aggregates have performed relative to that target, not only in the mandate horizon year but in other years previously. That is why we did a detailed explanation, even though 2015-16 is no longer the relevant end point for the mandate at the moment. We have also explained where the Government are relevant to the mandate target in 2015-16 and why that has changed. The best we can do is to be transparent about the other years, but the Government have chosen to have that horizon as the one that they focus on.
Q151 Mr McFadden: Can I just check, finally, whether you said that you agreed with Jonathan Portes that it does not ensure long-run sustainability?
Robert Chote: No, that is a different question. Our view was that on unchanged policy it did not in July, when we did the longer-term analysis.
Q152 Mr McFadden: I thought you said in your first answer that it does not ensure long-run sustainability because it is a five-year target.
Robert Chote: That’s right. I said that in July we actually showed that on unchanged policy, you end up with a rising debt-to-GPD ratio. On that basis, it is not sustainable in the longer term.
Q153 Chair: What do the Government get from you that they could not get from outside forecasters? I am just looking at your own estimate of your performance against outside forecasters in the forecast evaluation report. Given the very high level of uncertainty, which I accept and sympathise with-the point has been made by both Mr Chote and Professor Nickell-I would be interested to hear you make the case for having an OBR, or certainly an OBR like the one we have now, as against using outside independent forecasts as the basis for Government policy.
Robert Chote: Absolutely. The argument-we went through this when you were taking evidence on the structure of the organisation to begin with-is that in order to come up with a detailed, disaggregated, bottom-up fiscal forecast you need an economic forecast that extends over a five-year time horizon, which is relatively disaggregated on both the expenditure and income measures of GDP, because those affect the various tax bases and bases for spending. For the way in which we want to do it, you need something that is amenable to scenario analysis and sensitivity analysis.
Q154 Chair: That is the detail, though, isn’t it, Robert? On the major numbers, could those be taken from the external forecasters and then you could do the detailed work after that? After all, it is the major numbers that require the major revision of Government policy on the outer years for spending that you have altered here.
Robert Chote: The problem is that the number of forecasters that are producing a path for potential output over five years, which is what you need to get to the output gap at the end of the forecast, is not that great. If you took the average of-let’s take the output gap for this year.
Q155 Chair: I have understood that point. So if the forecasters started to do slightly longer-run projections, do you think that is something that we should consider?
Robert Chote: I always raise the issue about whether the OBR should be doing its own macro forecasts. I was more doubtful then than I am now, because of this issue about the type of detail and duration of forecast that you need in order to drive the fiscal forecast.
Chair: Maybe we should come back to this another time.
Q156 Jesse Norman: I am sure I am not the only member of the Committee who is worried about not only the accuracy of the forecasts but the whole illusion of technocratic expertise. I have no doubt that there is an enormous amount of expertise within the OBR, but we are in conditions of such uncertainty at the moment that there is a very high level of guesswork. My question on this is how, Mr Chote, do you want us or others to appraise the performance of the OBR over a period of time?
Robert Chote: As I said when I was asked this question at my confirmation hearing, I think primarily on the transparency, clarity and honesty with which we set out the projections. We should not be setting out one particular view of the economy and saying that the world will definitely turn out like that, then asking you or Ministers to take that on trust. We should be setting out as clearly as we can, and in as much detail as we can, the underlying working out that we have used to come up with the analysis. We should also be taking the time and effort to kick the tyres of the forecast and ask, "What difference does it make if we are wrong about the output gap-it is bigger or smaller-or we are wrong about the interest rates that the Government are paying, higher or lower? What if there was no hit to potential output as a result of the crisis?" We have to provide an evidence base, and it is for Ministers to take a decision, agreeing or disagreeing with it.
Q157 Jesse Norman: I do not want to cut you off, but we are short of time. The trouble is that there are central planks of the forecast that are theoretically dubious. The notion of the output gap at the moment is a black box. There are so many different variables that might affect whether the thing exists, or how large it is, that it is not just a question of how it is to be calculated, but whether or not there is a genuine piece of economic thought here at all. Is that not something you should be interrogating as you talk to the people who are building the model with you?
Robert Chote: To start, we have been asked to police a fiscal target that adjusts for the size of the output gap in 2016-17. We have to do that; there wouldn’t be any choice. That is an easy excuse-to say, "We have to do it for that reason." As I say, I think it is really the time horizon as much as the fact that it is a cyclically adjusted target. If you are looking over a five-year time horizon, it is pretty hard to come up with a mental model of how you think the economy works that does not rely on some version of what the likely path is, as best we can estimate it, of the economy’s ability to produce goods and services in a sustainable way, and how aggregate spending matches up to that.
Q158 Jesse Norman: What assumptions have you made about the existing drag on the economy and on GDP from the eurozone crisis? This is over the last six or 12 months.
Robert Chote: In the outturn data that we have seen, if you compare why the economy has grown less quickly than we anticipated it would back in June 2010, you can explain that, if you want to, pretty much entirely by the external inflation shocks-higher oil, food and import prices and so on, and the squeeze that that has put on household incomes and consumer spending. As we make very clear on here, the fact that you can explain it all by the use of that does not exclude the possibility that there are other factors going in both directions.
Q159 Jesse Norman: But how much would you attribute to the eurozone?
Robert Chote: Not much looking back; more, looking forward. If you think about the fact that we are expecting credit conditions to tighten into the fourth quarter of this year and to remain elevated over the next couple of years, and if you look at the evidence from consumer and business surveys, it is hard to imagine that events in the eurozone have not had a significant impact on that. However, I would say less so for explaining exactly why GDP or growth has turned out weaker than we have expected over the last few months.
Q160 Jesse Norman: It is compatible with your view though, is it not? It has been suggested that if there were a eurozone default, depending on how disorderly it was, it could knock 3% to 5% off UK GDP. That is not ruled out by your analysis.
Robert Chote: No, and as we say in the book, the forecast is basically conditioned on an assumption that the eurozone struggles through, by which I mean that everything does not turn out to be rosy in the garden straight away, and that you still have elevated credit conditions, for example. However, it is pretty impossible to come up with a representative scenario that describes a bad outcome for the eurozone, because that outcome could take so many different forms, depending on politics as much as anything else.
Q161 Jesse Norman: But it could certainly be a GDP shock of 3% to 5%, given the scale of our exports.
Robert Chote: The OECD had a stab at this in its most recent report, and that would be consistent with it.
Q162 Jesse Norman: Yes; the OECD also had a stab at making a guesstimate on growth, based on an assumption about quantitative easing. How do you evaluate that?
Robert Chote: I have not looked at the OECD’s particular work on that. In terms of the impact of quantitative easing, I do not think we would see a reason to take a very different view from the one expressed by the Bank of England in its quarterly bulletin article. There is obviously an issue at any time of how much of the impact of quantitative easing is already in the price. When the Bank announced QE2, there was not an enormous adjustment in yields on the day, presumably because lots of people had been expecting it to happen, and therefore it was priced into the considerable fall in the yield curve since we did our last forecast, for example, so disentangling that entirely is hard. I have no reason, however, to believe that the Bank is particularly awry in its assessment of the impact of QE1.
On the question of whether QE2 has the same level of impact, it is hard to be sure. Gilt yields are obviously lower than they were at the time of the first one, so you might think that there is a little less room for additional movement as a consequence.
Q163 Jesse Norman: Yes, as a repetition, you would expect less effect anyway, because of the discounting effect on expectations. And you make no assumption or have no views on the possibility of a QE3.
Robert Chote: No, our assumption for monetary policy is that it evolves as implied by the forward curve. If the markets are anticipating even more QE, and that is reflected in the current level of gilt yields, that would implicitly be reflected. Monetary policy is implicitly looser in our forecasts than it was at the time of the Bank’s November inflation report. How much of that is to do with expectations of future monetary policy or events in the euro area is anybody’s guess.
Q164 Jesse Norman: The OECD had an assumption of a further £75 billion of QE in its growth forecast. That feels very methodologically odd. Why would you make an assumption about that when you have no reason in advance to think that the Bank is proposing to do it?
Robert Chote: Well, it may have been based on their view that in the absence of a policy change such as that, the Bank would not have been on course to achieve the inflation target. I don’t know exactly why they have reached it, or whether it was a more high-level assumption about policy changes more broadly across the OECD countries, or whether it was that specific a judgment.
Q165 Stewart Hosie: Robert, in your detailed summary forecasts, you have business investment growth from 2012 through 2016 not of the previous 8% to 11% growth rate, but from a whopping 7.7% up to an unbelievable 12.6% growth rate. I was very sceptical of the last forecast which said it would be between 8% and 11% a year; I am even more sceptical that it is going to go from 7.7% up to 12.6%. Please explain how on earth you think business investment is going to hit these targets. These are very large numbers.
Robert Chote: Well, the average growth forecast is roughly 10% a year over the five-year period, which is pretty much exactly what it was in the ’94 to ’98 period. The difference now is that we have had a sharper fall in investments beforehand and therefore you are in a deeper hole from which you are emerging, so on that basis you would still end up at the end of this period with a relatively modest share of investment as a share of GDP. Clearly there are huge uncertainties about this. We have discussed, for example, having a fresh look at the evidence on the amount of cash that happens to be sitting on large companies’ balance sheets and what that is available for, but obviously their other decisions will be based on their perception of how the rest of the economy and consumer demand is going to be doing as well. But I think in historical terms, having a profile of changes that is roughly equal to the ’90s, despite the fact that we are at a lower starting point, seems to us to be a reasonable assumption, albeit one with considerable uncertainty around it.
Q166 Stewart Hosie: Except the investment decisions will be based on whether there can be a return. The autumn statement has confirmed that real incomes will fall over the piece. On pages 82 and 83 you say that outlook for the euro area has deteriorated significantly; that substantial revisions to US output data showed that the recovery had been weaker, with a considerable downward revision in growth for the first quarter; the near-term indicators point to slower trade growth with US, German and Asian manufacturers, etc, etc. Given this evidence-and it’s your evidence-why would anyone choose to invest to the extent that your forecast would suggest?
Robert Chote: As I said, the fact that we are getting to a relatively low share of investment as a share of GDP would give some reassurance there. The other thing to bear in mind is that you are getting into a position, because investment has fallen so sharply, that actually replacing capital becomes increasingly important as a floor to this. So there are not just the expectations of future demand there, but the fact that you have more capital equipment that simply needs to be replaced on that basis. So that is another argument.
Q167 Stewart Hosie: On that, we all remember previous recessions where the steel plant was dismantled and sent to China or the car factory was dismantled and sent to India. We have not seen that sort of erosion of physical capacity in this downturn so why would you assume there is going to be the requirement to replace the type of capital goods that we have not seen eroded in the way we did graphically in previous downturns?
Robert Chote: If you look at the survey evidence of why investment intentions remain as buoyant as they are now, you have people talking about the need to replace capital as a relatively important explanation for that. We are talking about a set of growth rates that are no higher than the ones in the 1990s but from a lower starting point. So I would not be trying to claim that we have got an investment boom coming by historical standards.
Q168 Stewart Hosie: One of the policies the Government have pursued in terms of SME lending is to guarantee £20 billion off lending. That is quite a big amount of money in GDP terms. But if, as we heard yesterday, it is not price or availability that is the issue but aggregate demand, then those investment figures cannot be met, can they?
Robert Chote: On the demand and supply issues, the loan guarantee is trying particularly to address the difficulties of small and medium-sized enterprises over the medium-term horizon. As I said, there is a combination of needing to replace capital and the fact that you have a pick-up, albeit not a rapid one, in consumer spending, for example. We have a very sharp fall in real household disposable income this year because of the price shocks that were squeezing incomes. Presumably we will not have another rise in VAT next year; certainly that is not current policy. If you get the increases in commodity prices dropping out-we may or may not get further increases in utility prices-you could see a better picture for consumer spending over the longer term. We get back to a position in which earnings begin to outpace inflation a little bit in 2013, and by more in 2014, so I would not be entirely despairing there, but I am not claiming that it is rapid.
Q169 Stewart Hosie: Just one final question, and in terms of this business investment. For 2012, business investment-according to your figures in table 3.4-makes up 0.6 of the entire 0.7 forecast growth rate. If business investment is not 7.7 to 12.6, but the 0.8 we had two years ago, or the minus 0.8 we have this year, there will be no growth next year. Growth would be down 40% the following year and might be down 30% the year after that. You seem to be putting a great deal of stock on business investment to meet any sort of growth forecast over the next three years. Are you not anxious that a huge chunk of GDP growth, and next year almost the whole of GDP growth, is dependent on business investment, which seems, as I say, quite heroic in terms of some of the figures we have in the book?
Robert Chote: One is always nervous about those sorts of figures over that sort of time horizon, but given the sort of evidence you have at the moment about investment intentions, that seems to us to be a central forecast. But, arithmetically, you are absolutely right that if that does not deliver, and everything else is unchanged as a consequence, you end up with a weaker aggregate picture.
Q170 Stewart Hosie: Just one final question. If I am right, and I hope I am not, and that business investment does not come and we have flat growth next year, it means both Government targets are almost impossible to meet. Is that not right?
Robert Chote: In terms of the mandate, it depends on how much any additional weakness in the economy is an additional structural problem versus greater cyclical weakness and greater cyclical borrowing in the short term, which might make life more difficult for the debt target in 2015-16. If it were a temporary factor, it would not necessarily be an issue as far as the mandate is concerned. You have to bear in mind as well, when we are talking about the robustness of the evidence base, that investment data are very volatile on a quarter-to-quarter basis and are prone to considerable revision. When we last met, I think you asked whether we could realistically expect to see the improvement in export performance that we were anticipating. It now turns out that more of that had actually happened in the outturn data, and we are now more pessimistic about that looking forward. I think we were as surprised as anybody that exports had picked up by more in response to sterling’s weakness than we thought when we were having this conversation back in March.
Stewart Hosie: Let’s wait until the next revision.
Q171 Andrea Leadsom: I would like to talk to you a bit about bank lending. Specifically, you have said in your paper that, since your March forecast, prospects for a swift resolution of the euro area sovereign debt crisis have receded, which I take to be a backwards way of saying that the chance of a swift resolution has gone and, therefore, bank lending is inevitably tied up with the confidence levels in the eurozone, yet you have not really included any analysis. Obviously, this is the very sharp end of speculating about impossible future prospects, but can you talk to us a bit about what you think is going on in the bank lending market now and how it is likely to be changed? Do you think that bank lending is drying up? Do you think there are genuine issues with that? Do you see that easing, or what direction of travel do you think it is going in?
Robert Chote: I’ll ask Steve to say a bit more about this, but if you look at the bank funding costs, they have clearly risen and the developments in the eurozone have had an important influence on that as well. Now, as it happens, the banks have not come to market to get a great deal of funding. They appear to have had enough of it in the first half of the year that they thought that they could get by on that, so to speak. Clearly, the longer those difficulties persist, the sooner it comes to the point at which that feeds through to the rates that businesses are paying. We are anticipating that as a result of this delayed impact, you end up with credit conditions tightening into the fourth quarter of this year, remaining elevated into the first quarter of next year and then gradually improving thereafter.
As you point out, a lot of this depends on the persistence of the eurozone, or indeed other factors that may be affecting bank funding costs. One of the things that we have done in the scenario section of the report is say, "What difference would it make if those bank funding costs remain elevated for a further year?" That could be a consequence of the eurozone or could be a consequence of other factors as well. We outline there that that would make the activity in the economy weaker and make the fiscal position more difficult. Steve, is there anything you want to add to that?
Steve Nickell: No, I think that just about sums it up. The prospects for bank lending are extremely uncertain in the sense that the banking system is in a state at the moment where the banks do not trust each other very much. There is lots of evidence that the banks are very worried about counter-party risk and that they are being extremely cautious about lending to each other, and so on and so forth. That is partly coming out of the eurozone crisis.
We have to make some kind of assumptions about when this is going to end and things get back somewhere towards normal. Basically, that is a guess. We do not have any more inside information than anybody else on that matter. Basically, we make an assumption that over a two-year period things get back towards normal, although normal is more elevated credit restrictions than were ruling before 2007. We are not ever expecting to get back to what life was like in these markets before 2007, but we expect to get back to some degree of long-term normality in about two years. As we are only too happy to admit, that is very uncertain and is a guess.
Q172 Andrea Leadsom: So, how would it affect your core forecast in the event, for example, that a country were to leave the euro or that there was a bank lending dry-up like there was in the wake of the Lehman’s collapse? Presumably those factors would dramatically change your forecast.
Steve Nickell: Of course that all depends on how the changes you describe play out. In some sense, it should not be beyond the wit of man to devise a mechanism whereby Greece leaving the eurozone could not be to some extent ring-fenced, because Greece is, after all, so small relative to the totality of the eurozone. If you look at the actual holdings of foreign banks in Greek debt, they are relatively tiny. You would hope that, were Greece to leave the eurozone, some ring-fencing mechanism could be found. However, if the eurozone deterioration is more generalised, things could be a lot worse, because cross-holdings of sovereign debt in the banking system for Italy, Spain and so on are really rather substantial and you could see something fairly disastrous.
As Robert said, if you look at our scenario 1, which is the one where there are persistent tight credit conditions, even in that scenario, they are only persistent for one more year. The consequences of that scenario are quite severe.
Q173 Andrea Leadsom: So, it is a big risk factor for the forecasting.
Steve Nickell: It is a big risk factor.
Q174 Andrea Leadsom: Can I ask just one other question, specifically about SME lending? You may not have done this research, but do you think that the problems with SME lending are more about the availability of money or the price? What is the impact of the current tight lending conditions on SME lending?
Robert Chote: I think there is clearly a combination of demand and supply issues there. You have the fact that SMEs are obviously more reliant on the banks, and therefore there is that concern. You have also got them worried about whether now is the time to be investing anyway. I think you have the evidence from various agents and other surveys that there is a mixture of both those things happening at the same time.
Obviously, the Government are trying to act on the credit availability side with the loan guarantee scheme. It will be interesting to see how that fleshes out over the next few months, because the success of that depends on a number of factors. To what extent can the banks be encouraged to pass on the lower funding costs they get as a result of the scheme to the SMEs? Is that additional SME lending, or merely subsidising lending to SMEs that would have happened already? If it is additional SME lending, is it additional aggregate lending overall or will it be offset by less lending to larger businesses or to households? All that will affect the aggregate impact that that has on the economy as a whole. That is why I think that seeing how the details of the scheme flesh out will be important to assessing how successful that is likely to be.
Q175 Andrea Leadsom: In your report, you say, "An ONS survey reports that the demand for credit SMEs held up between 2007 and 2010 but that their success in obtaining bank lending fell markedly". That suggests that it is the availability of bank lending. Are you in favour of the credit easing programme in the Autumn Statement? Do you think that can address this? Can it make SME lending easier in future?
Robert Chote: Again, Parliament has instructed us not to talk about the merits of particular measures, but clearly you can see the rationale for this. The fact that we have not made an assumption in the economic forecast about exactly what contribution this can make is an indication of the fact that, because of all those various channels I have just described, you probably need more detail to know how likely that is to be effective in channelling the money to the SMEs and the impact more widely, once other potential offsetting changes have taken place as well.
Q176 Andrea Leadsom: Okay, can I just be clear? You wouldn’t ever take into account the potential beneficial impact of a particular policy in doing your forecasting?
Robert Chote: Oh no, we do.
Andrea Leadsom: You do.
Robert Chote: We are tasked with not saying whether it is a good idea or not.
Andrea Leadsom: Right.
Robert Chote: The Government will have a variety of reasons why they want to do a particular policy, and it is not for us to say. What we are challenged with doing is saying what is our best guess-our best judgment-about the likely impact of this, once we have enough details of how the policy is likely to work, in order to estimate that.
Q177 Andrea Leadsom: Right, so you have taken into account the likely impact of that policy.
Robert Chote: What we have said here is that at the moment it is too early to tell. Once we have more detail to that policy you will get a clear idea of how important each of those channels is going to be. I suspect it is something where the details will be considerably clearer, presumably, by the time we get to the spring forecast.
Q178 Mr Love: Earlier, Robert, your explanation of the deterioration in the forecast from May to now was primarily the squeeze on incomes caused by higher international inflation. In your forecast for next year, that squeeze continues-it is 0.3%-yet you are suggesting that consumer expenditure will rise. How do you reach that conclusion?
Robert Chote: The impact of the higher inflation has been, we think, an important factor in explaining the outturns-why things have turned out to be weaker in the recent data than anticipated. We end up with the squeeze on consumers being less severe. It is still by no means a return to normality next year, because we are working on the assumption that you do not get a continuation of the same sorts of price shocks that squeezed consumer spending as you did last time. We know there is not another increase in VAT in the pipeline as an announced policy. We take the forward path for oil prices, for example. That may or may not be a good guide to what turns out, but it is not implying a continued squeeze from that source. We do not think it is reasonable to assume that you have necessarily got the same sort of squeeze repeating itself on food prices and so on.
For all those reasons, inflation should be doing less to squeeze households next year than was the case this year, but you still have a gradual improvement over time. We are not back to the normal world in which earnings are outpacing inflation by a significant margin until 2014, which is one of the reasons why the recovery in consumer spending is not greater than it is there.
Q179 Mr Love: I do not want to look at 2014, because we have already decided that forecasts at that long a time horizon are completely useless, or that seemed to be the implication of our earlier discussion. I want to look just at 2012. I put it to you that we are currently seeing record negative equity withdrawal, so people are actually paying back their mortgages in record amounts. Unemployment continues to rise through 2012 and that will have an impact on long-term unemployment continuing to rise. What gives you the confidence that consumer expenditure will pick up in those circumstances?
Robert Chote: As I said, it is the judgment that we have reached on balancing those factors against the fact that we are not expecting the same record squeeze on real household disposable incomes, because of the pressures on the inflation side. But as you say, given the profile that we have for average earnings, we have that returning to the normal nominal increases that you would expect over a relatively extended time horizon, so we are not assuming that there is any big bounceback there in the short term.
Q180 Mr Love: Picking up on what Mr Hosie said in relation to business investment, I am interested that you quite rightly said that it is almost impossible to predict what will happen in the euro area, but that you had assumed a muddling through. The National Institute have assumed the same, but they come to a very different conclusion from you in terms of business investment. Without wishing to go over all the issues that Mr Hosie went through, they were suggesting that, according to market sentiment, business investment would deteriorate very significantly, which is an enormous contrast to your suggestion, and I understand the reasons why you have put forward that there will be significant growth in business investment. Are you not concerned that the impact of the euro muddling through over the next year is likely to have-and seems to be having-a very adverse impact on business investment?
Robert Chote: Yes, business investment, as you point out, is affected by the expectations of what is going to happen in the eurozone. It will be affected by broader expectations about the outlook for the economy and domestic demand as well. It is certainly something to be nervous about. As I said, business investment numbers are very volatile. They are heavily revised as well, so working out exactly what is going to happen on that next year is not at all easy. We think we have the balance right, but it is entirely understandable that some people are going to come up with weaker and stronger pictures for that.
Q181 Mr Love: How about the position in relation to net trade? You marked down your figures, I think, as a consequence, but do you think you have gone far enough in terms of the impact that the euro uncertainty will have on the trading position?
Robert Chote: Obviously, it depends on how the euro uncertainty continues to evolve. Yesterday, everybody was briefly tremendously enthusiastic, but it remains to be seen how long that will last. In the central forecast, we have a fairly typical forecast for eurozone growth next year. If you look at our forecast of aggregate imports by the eurozone from outside the eurozone, which is actually more pertinent for its impact on the UK, we have a relatively weak forecast for that, so we are not banking on a big increase in imports out of the eurozone, but clearly, in terms of what happens to sentiment, that seems to be moving on a day-to-day basis as the policy world moves ahead on the eurozone resolution efforts.
Q182 Mr Love: Finally, as I understand it, you have suggested that there is a one-in-three possibility that we will have a technical recession over the next year. The National Institute is a little more sceptical, and it suggests that there will probably be a very short recession at the beginning of 2012. Of course, the OECD has suggested that there will be a longer and perhaps slightly deeper recession. With all the uncertainties, are you convinced that it is only a one-in-three possibility?
Robert Chote: I am not at all convinced that it is only a one-in-three probability. We essentially have a picture of the underlying momentum of the economy weakening into this quarter of the year, then gradually picking up through the course of 2012, partly because of the same sort of one-off factors that mixed up the quarterly growth profile last year-the royal wedding and so on. The combination of the Olympics and the jubilee I think will shift some of the headline economic activity out of the first half of the year and into the second half of the year. As a result of that, we basically have either a fall or an increase in GDP of 0.1% in each of those three quarters, so clearly-
Q183 Mr Love: That is very convenient, isn’t it?
Robert Chote: The OECD’s view that we are already embarked on a double-dip recession is based, I think, on a 0.02% decline in GDP, which would strain even the most enthusiastic forecaster’s belief in their own prescience. It is not a particularly useful question to answer in terms of the underlying implications for the longer-term path of the economy. The other thing you can do is look at the aggregate figure for growth next year as a whole and say, "Look, given the past forecast errors around a calendar-year growth rate, what are the chances of 0.7 actually not being positive?" Again, it is roughly one in three.
Steve Nickell: One thing you might want to look out for is that if we have a huge bout of snow, it will probably rule out a double dip recession because GDP will fall in the fourth quarter and bounce back in the first quarter, and away disappears your double dip recession.
Graham Parker: If it snows in January-
Steve Nickell: No, if it snows in December. It has to snow in the fourth quarter.
Q184 Mr Love: So we are subject not only to economic circumstances, but to physical and weather circumstances?
Robert Chote: As we were in the last quarter of last year.
Q185 Mr Ruffley: May I return to our old friend the output gap, because a lot is riding on this? I do not know why you are laughing, it is a serious matter. The Chancellor’s reputation is riding on how good your forecasting is. In your November report you said, "Rather than assuming that the growth of potential output snaps straight back to 2.3 per cent, our estimate of its long-run average, we now assume that it picks up gradually over the next two years as the financial sector and credit conditions normalise." The first question I have is, why on earth would you expect it to snap straight back to 2.3%? I know you have talked about the long-run historical average, which I understand-I know it is what led you to that conclusion-but with all the evidence you were looking at and the business surveys, how did you ever come to the conclusion that it would snap straight back to 2.3% last March?
Robert Chote: Because at that stage we did not have the extended evidence that we do now of how weakly potential output growth had taken place from-
Q186 Mr Ruffley: Professor Nickell seemed to imply that that new evidence was just business surveys. It cannot just be that.
Steve Nickell: No, it is business surveys relative to what happened. That is to say that output was relatively flat, well below any conceivable notion of trend, yet the business surveys did not indicate that there was a great increase in spare capacity, which suggests that potential output growth was much flatter than we had expected. So it is not just business surveys; it is business surveys relative to what happened to GDP. That was the evidence.
Q187 Mr Ruffley: "We now assume that it picks up gradually over the next two years as the financial sector and credit conditions normalise." Could you explain that statement?
Robert Chote: We assume that there is a gradual change from the recent outturn data on growth potential to the unchanged assumption about where it is in the longer term. We then have to make a judgment on how quickly that process takes place, given that that long-term assumption is still the best one we have. As you said, it now seems incredible to assume that you just have that immediate snap back, so the question then is, can you reach a judgment over what is the appropriate time horizon for that to take place? Our best judgment, and it is a judgment, is that a couple of years to see credit conditions returning to something more like a new normal level and the financial sector getting back into some sort of health seems appropriate, but the very fact that we have included a scenario showing what happens if that time horizon is different indicates the-
Q188 Mr Ruffley: But could you give us some metrics, because this is actually an important point? You got it horribly wrong last time. We hope you are now assuming correctly in this November report that we are talking to you about. You assume it picks up gradually over the next two years, as the financial sector and credit conditions normalise, but can you try to quantify for us, in very general terms, what normalisation of credit conditions and the normalisation of the financial sector actually mean? These are not just qualitative judgments; give us some quantification of what that looks like.
Robert Chote: Bank lending costs returning to something more like the levels that you saw, not in the immediate run-up to the recession, but in the-
Q189 Mr Ruffley: So pre-crisis levels?
Robert Chote: Yes. As I say, not back to what was probably an unsustainable immediate pre-crisis level, but to something more reasonable as a longer-term expectation. In terms of looking at-
Q190 Mr Ruffley: That is credit conditions. What do you mean about the financial sector? Are you talking about the health of the financial services industry, the profits it generates and the tax it pays on those profits, or what? I just want to understand what you mean.
Robert Chote: It is ability to help the economy reallocate capital from relatively inefficient to more productive activities.
Q191 Mr Ruffley: And what is the evidence you have for assuming that this will happen gradually over the next two years?
Robert Chote: As I have just told you, it is a judgment based on the fact that you are getting from the recent path of output data to what we believe remains, imperfectly, the best assumption about what the long-term trend growth rate of the economy is, and to reach a judgment about the time horizon over which you do that.
Q192 Mr Ruffley: But you are looking at growth data in the economy as a whole-the real economy and investment decisions.
Robert Chote: As Professor Nickell said, we are looking at the cyclical indicators of the amount of spare capacity in the economy-so, what you get from business surveys, what you get from the performance of average earnings and how that has performed relative to aggregate activity in the economy as measured by GDP. In terms of whether this is right or wrong, the level of potential is not an observable variable. Inconclusive PhDs will be being written on what the level of potential GDP is now and in the near future in 20 years’ time.
Q193 Mr Ruffley: I think we understand that. My final question is: what did other independent external forecasters say to you when you made, to use your word, this "reassessment" of the size of the output gap? Were they sort of agreeing with you or were they saying you screwed it up? What was the general reaction of other economists?
Robert Chote: A mixture, reflecting the fact that our estimate of the output gap at the moment is broadly in the middle of the range. The Treasury’s monthly survey asks independent City and academic forecasters how big the output gap is at the moment. In the one they produced last month, the average estimate was 1.7%-so a smaller output gap than we have. We also look in particular at the large international forecasters-the IMF, the OECD and so on-because they also provide longer-term forecasts for potential, which we can compare. Those tend to be slightly higher-in the threes per cent. There is a range from a negative output gap of 0.5% to a negative output gap of 4%. We are at 2.5%, and I think the-
Q194 Mr Ruffley: So 2.5% for the third quarter. Can I just confirm this-
Robert Chote: Popular reaction has reflected that range. Some people say it is too pessimistic, some too optimistic.
Q195 Mr Ruffley: You have actually changed it by 0.5%. Can you just confirm that if you actually have to alter your forecasts for the output gap by 0.75% the next time you report, in March, the Government would no longer be on course to meet their fiscally neutral, cyclically adjusted balance?
Robert Chote: Other things being equal, that is right. That is what we say in the sensitivity analysis, where we probe exactly what difference it makes if those numbers turn out to be different.
Q196 Chair: You have hinted at some other material that you have got, knocking around, to support your view about the output gap, beyond what you published in box 3.1. You were talking about other surveys.
Robert Chote: Oh, right. You know the Treasury produces this monthly summary of what other people are saying-it is just basically taking the data from that.
Q197 Chair: You have heard the scepticism from all sides of this Committee-certainly, cautions-about the sharp change that you have made in response to what appears to be something that has occurred only over six months’ changes in data, and which rests heavily on what is provided in box 3.1. If the OBR has further material that you want to provide to the Committee, we would be grateful if you would do so as soon as possible. You might want to take that thought away and consider it.
Robert Chote: You might want to have a look, for example, at the analysis we produced alongside this report of the historical path of the output gap, in which we have looked at production function measures and statistical filters. That provides some additional evidence of how difficult it is to come up with estimates.
Chair: I took a look at that analysis yesterday. I leave it with you to reflect on, because it is something that we are clearly concerned about as a group.
Q198 Mark Garnier: In the Government’s national infrastructure plan, there is an expectation of more than £250 billion being invested into infrastructure by 2015 and beyond. How realistic do you think that is?
Robert Chote: I do not know. We have not looked at the implications, because the Treasury did not come to us with that as a policy that they wanted us to scrutinise in advance. We have taken the capital spending plans that they intend to fund and incorporated them, as would always be the case, in terms of the contribution of Government capital expenditure to the overall forecast. We have not taken a view on how successful it is to try to get the private sector to invest in other sorts of infrastructure projects. That, presumably, will depend on how successfully these can be arranged to ensure they get a return from them.
Q199 Mark Garnier: So how much have you allocated for infrastructure spending in your forecast?
Steve Nickell: By the Government or in general?
Mark Garnier: Both.
Robert Chote: We forecast an aggregate investment number, which includes residential and business investment, then we take the Government’s capital spending plans and assume that those are delivered. There is clearly uncertainty at any time over whether the Government will spend quite the amount that they anticipate on capital spending. We take the view, however, that unless there is short-term evidence of underspending or overspending in a particular year, the Government will deliver the capital spending plans that are consistent with the numbers set out in the spending review, adjusted for the additional reallocation of capital spending that they made in the autumn statement.
Steve Nickell: But we do not have anything about private sector infrastructure investment as opposed to any other sort of business investment.
Q200 Mark Garnier: So you take no consideration of this expectation of £250 billion of infrastructure investment-is that what you are effectively saying?
Robert Chote: The Treasury comes to us with policy proposals that it wishes to make and announce on the day of the statement, and it did not come to us with the details of the national infrastructure plan on that basis.
Q201 Mark Garnier: It is quite important; this is £250 billion-worth of potential expenditure or investment into infrastructure in the economy between now and 2015-and beyond, whatever that means. That is quite a big deal, isn’t it, to leave out of your expectations?
Robert Chote: If one were confident that that would materialise. It depends on whether you get more data over time as to whether that is likely to affect it or not.
Q202 Mark Garnier: From what you have seen over the past week or so, how confident are you that £250 billion is likely to materialise, let’s say to 2017 rather than this hazy "and beyond"?
Robert Chote: I would not describe the evidence base as strong enough to include that in a central forecast, necessarily.
Q203 Mark Garnier: So what you are saying is that you do not think there is much chance at all.
Robert Chote: I am not saying that. I am saying that I will look forward to seeing more evidence mount over time as to whether that is a realistic expectation.
Q204 Mark Garnier: You sound rather hazy about this.
Robert Chote: Whereas you think it is very clear-cut as to whether this is going to materialise or not?
Q205 Mark Garnier: It is a very interesting proposition, because there is evidence elsewhere in the world, where you see corporates that are coming into infrastructure plans. If you look at somewhere like Hong Kong, for example, you have infrastructure development such as the Cross-Harbour tunnel. Such development has been around for years and years, so this is not a new thing. The fact of the matter is that if business sees an opportunity, it will invest in something. Part of the issue is how you get a payback-can this be some kind of son of PFI, or can it be a toll road? I was going to explore your general considered opinion of what sort of opportunities there are, but it sounds as though you might shrug your shoulders and say, "That is beyond my pay scale."
Robert Chote: It is beyond my knowledge base. At this stage, there is not the evidence. As you have said, the Government have laid out a variety of things that they would like the private sector to be involved in and, as you rightly point out, there are different channels through which that could take place. It is not for us to judge at this stage what the scope is for particular toll roads and what impact that could have.
Q206 Mark Garnier: But you have seen that some toll roads have been started. You have got the Severn crossing, which is a toll bridge. You know that they exist, but you have not made an assessment of what the potential is.
Steve Nickell: No, we have not.
Q207 Mark Garnier: So all of this £250 billion, to be absolutely clear, is all blue-sky, upside to your estimates?
Steve Nickell: No. We have an investment forecast-a business investment forecast which one of your colleagues thought was very optimistic. The business investment forecast generates about £160 billion a year, and presumably part of that is private sector infrastructure investment, but we do not know because we are not in a position to analyse business investment down to its constituent parts of infrastructure investment and other sorts of investment. In fact I do not believe the data exist to enable us to do that.
Q208 Mark Garnier: I am slightly stunned by your answers. I was expecting it to be a rather easy session for you but it is not. You seem to have made very little estimate of what is going to be invested by the private sector into the infrastructure. The Government has specifically set out that it is looking to create a way that there can be £250 billion and more by 2015 and beyond, but you are saying that you are not really making any specific analysis of that, or any assumption. You will obviously steer away from trying to make a qualitative analysis of whether that is going to be right or wrong, but given that the Government have said this, you are saying that you are not taking this into account specifically and that you are mashing this in with the business investment in general and only looking at £5 billion of Government investment into the infrastructure, which is a minute proportion of this. As I say, I am completely stunned that you are looking at the future of our economy to 2015 and beyond without necessarily taking account of this potential colossal investment.
Robert Chote: There is an issue about how much of this would happen by 2015-
Q209 Mark Garnier: Well it was originally-
Robert Chote: As Steve said, we have an aggregate investment forecast. The Treasury obviously come to us in advance when we are putting this report together to tell us of the policy measures they believe we ought to take into account in the central economic forecast. They did not come to us with a big thick book, saying, "Please could you take this lot into account". You will have to ask them when they appear before you, whenever they do, over what time period they expect this to happen and how confident they are, et cetera, or whether they regard this as potential that they wish to explore and how easy it is to unlock.
Q210 Chair: What did they say?
Robert Chote: As I say, they did not come to us with this.
Q211 Mark Garnier: You must have read it though.
Robert Chote: Yes, but as we were putting this forecast together.
Q212 Chair: Not before you did the forecast?
Robert Chote: No.
Q213 Chair: You had no knowledge of it whatsoever? Just to be clear-you knew nothing whatever about what the Government were planning in the autumn statement? You put this together on the basis-
Robert Chote: Well, on that particular-
Q214 Chair: On this large item in the autumn statement-just this large item-you knew nothing about it whatsoever?
Robert Chote: We knew no more than what all of us read in the newspapers.
Q215 Chair: You have now had a chance to look at it. Would you revise your judgment in any way in the light of it?
Robert Chote: I don’t think so. I think we would-
Q216 Mark Garnier: Why not?
Robert Chote: They are identifying potential schemes here. The question is whether they can be designed in such a way that they deliver. As I say, we have an aggregate forecast for business investment. It is not clear how much of this would effectively be a substitute for some of the things that would be within that total amount.
Q217 Mark Garnier: When are you going to go away and factor these numbers-the national infrastructure programme-into your forecasts?
Robert Chote: Obviously when we get to the next forecast, that information is out there and we shall see what evidence there is to support it at that stage.
Q218 Chair: When the Government announces that it is going to increase public spending for the forward years for a given sum-on health, say-do you factor that in or do you decide, "Well, we’ll have to wait and see. We want to see the colour of their money before we put it into the forecast"?
Robert Chote: No. Well, they will come to us with anything that affects a scorecard measure-so, any tax measure and any announcement of reallocation within the spending review. Obviously, we do not look at the reallocation of more on health or less on overseas aid and all those sorts of things. We take the aggregates for current and capital spending implied by the Government’s plans and any updates they make to those and take those into the forecast.
Q219 Mr Mudie: Is this why you say, "we have not made any material adjustments to our economy forecast on the basis of these policy announcements"?
Robert Chote: That is referring to the policy announcements we were told about ahead of the forecast.
Q220 Mr Mudie: In annex A you list all the policy announcements.
Robert Chote: So they are in there. The big ones that matter in terms of their likely impact on the economy are the additional public services expenditure cuts announced for 2015-16 and 2016-17. The view we have taken there is that those directly reduce the contribution to GDP from Government consumption, but because they are at that time horizon-beyond the Bank of England’s two to three-year policy forecasting horizon-we would expect that the impact of those on the aggregate strength of the economy will be offset by changes in monetary policy. The consequence of those two is to make a change to the composition of economic activity in 2015-16 and 2016-17, but not to the aggregate. The other is the national loan guarantee scheme, which we were discussing with Ms Leadsom, and again we have taken the view that we do not have enough evidence yet on that.
Q221 Mr Mudie: Robert, I understand that. I come back to what Mark and the Chair said-a sum of £250 billion in a national infrastructure fund was put on the table and you have largely ignored it. I think you said that you were confident it would materialise. How often do you take that sort of judgment on Government announcements?
Robert Chote: In the run-up to this process-
Q222 Mr Mudie: Do you mark them with an asterisk, meaning, "This we don’t believe" or "This we believe"?
Robert Chote: As you see, we have a box that sets out the key policy changes that the Government have told us about in advance of the forecast which we think may have a potential impact on the economy, and we explain in each case how we have dealt with them.
Q223 Mr Mudie: The politicians around this table think that if you put a figure like that into infrastructure, it needs people to dig the roads and it needs people to do this and that-it should have a specific effect on employment. That is why there is great pressure on the Government to do this. Is that not a key feature of your report?
Robert Chote: As I said, the very fact that the Treasury did not come to us and say, "This is a policy that we think you ought to include in your report because we think there is a confidently estimable impact it would make on the aggregate economic forecasts", tells you something about the amount of evidence there is at this stage. That is not to rule out the fact that there is potential for this, and that might affect our future business investment forecast.
Q224 Mr Mudie: What use are you to the Government if you are saying the Government told you everything but the big one? You have produced a report that looks at this year, next year and the year after, and the Government have held one back from you.
Steve Nickell: This £250 billion is not a Government expenditure proposal.
Q225 Mr Mudie: No, Stephen, you miss the point I am making. Money is one thing, but employment is another. You cannot put £250 billion in the economy-
Steve Nickell: But the Government are not putting £250 billion into the economy.
Q226 Mr Mudie: Someone is. That money is going to pay for materials and wages.
Steve Nickell: I understand that perfectly; someone is putting it in. The Government are therefore producing a forecast of the consequence of their proposals for business investment, but they are not saying whether or not the consequence of their proposals for business investment will mean that other proposals and other business investments will not be undertaken as a consequence. There is only so much money in the private sector to spend on that sort of thing.
Q227 Mr Mudie: Do you think that you can just put £250 billion into an economy? Alternatively, let me ask the three of you directly: if the Government had told you this, would it have affected the employment figures?
Steve Nickell: Not unless the Government had given us some notion of the extent to which they believed the £250 billion was going to be additional to the existing £160 billion a year of business investment that was already going to be taking place.
Q228 Mr Mudie: In my understanding, this is only about £50 billion additional, and it is on top of a previous announcement of £200 billion. This is just an announcement saying that they are prioritising it, and they are actually going to look and see if they can get private investment rather than their money. All that has some effect. Have you not got that already written in, about capital sums that have employment consequences?
Steve Nickell: Yes. We have made the best possible prediction we can of business investment, containing all the information we have about what determines business investment. In that sense, it is the best estimate we have. If an increased part of that business investment is going to be on infrastructure, it is not something we can make a specific adjustment for, because there is no particular reason to believe that the announcements we have seen so far will have an overall effect on business investment.
Q229 Mr Mudie: I am not worried about business investment.
Steve Nickell: Well, this is business investment.
Q230 Mr Mudie: You can categorise that. That is one way of looking at it, but for this discussion, it is the effect of £250 billion that we have put in the economy, perhaps from two sources-private and public. Fine. You have an interest in the sources and that would affect how you write it up in the book, in a way, but a key part-the key part-is people in work. That has to have an effect.
Robert Chote: But you cannot stick it in the employment forecast and not have this in the investment forecast.
Q231 Mr Mudie: This is November. When you were preparing this, did you not ask the Government for their up-to-date figures on their investment in 2010 so far? How much of that capital has been started, or how much has been spent to date, so you can get an idea of their take-up? Have you asked the Government, on the original £200 billion, how they have divided that over the years? They did not just lump £200 billion in and say, "That’s going to be spent in 2010-11." They would phase it. In fact, I think the phase here is beyond 2015, but have you not asked?
Steve Nickell: But the Government-
Q232 Mr Mudie: Stephen, you have come to the Committee before and I have taken up the cudgels on your behalf with the local government people and the health people, in terms of them not giving you decent employment figures. Here is a big capital sum given to the Government and put in the accounts, and you do not appear to have asked them to give you an annual programme.
Steve Nickell: No. The Government provide us with annual numbers for general Government investment expenditure. We have the numbers. They are here in the forecast. There is this additional expenditure that is going to come from the private sector that we have not explicitly included in our forecast, because we do not have explicit information. As I say, we make the best possible judgments we can about what business is going to spend on investment-
Q233 Mr Mudie: No. It is not additional money. It is not different money. They had the £200 billion in their accounts last year. This is an additional £50 billion to make it £250 billion, and the new idea is that two thirds of that will be paid by the pension funds and private sector money. That affects you, if you wish, in a marginal way, I suppose, but it does not affect the outcome in terms of what will be built, and who is going to work. That is the key thing from the accounts point of view.
May I ask you something, Robert? You have come to the Committee before, and you are very clear and satisfied that the private sector will grow the jobs to compensate for the lack of jobs in the public sector. The witnesses who came yesterday said that on the second biggest part of this spending-transport-80% of it was in London and the south-east, and only 7.5% was spent in the north. The north is very dependent on public sector jobs. If all this money is coming through and is going to London and the south-east, it confirms this stuff from the IPPR that suggests that north of Watford is going to take many years longer than the south to recover from the recession. You would not be able to take that into consideration, because you do not bother with those figures, do you?
Robert Chote: We do not do a regional economic forecast: we are forecasting the national aggregates. Your point that we are very satisfied and confident about the balance between public and private sector employment is rather overstating the degree of certainty we put round those estimates, but the regional breakdown is outside our remit.
Q234 Chair: At the time of the Budget, a number of items that the Government announced were notified to you less than a fortnight before you were due to report, and you set them aside and did not put them into your forecast. We asked you to take a look at that and reconsider the time bar. What did you do about that?
Robert Chote: There was only one measure that came too late to include in the-
Q235 Chair: But what have you done about the time bar-the fortnight?
Robert Chote: The time bar has narrowed somewhat, partly as driven by the GDP data, which meant that we ended up close-
Q236 Chair: We asked for this to be done, so what is the time bar now?
Robert Chote: We revisit it with every forecast that we do. It was a more compressed process at the end on this occasion. The statement was a day earlier in the week and you had the closing down of the economic forecast a bit later, partly because of the GDP numbers, too. The balance of when we needed to be informed about things to have them included worked reasonably well, so it did move in the direction that you were arguing for last time.
Q237 Chair: I am trying to get in-I have had three goes so far. I am trying to find out how much the time bar moved in the direction we wanted, and Mr Parker is providing you with the answer, I think.
Robert Chote: We describe in the foreword the dates on which various things took place in the forecast.
Q238 Chair: What I want to know is what time bar you are operating on now. Is it less than a week, fewer than 10 days? If the Government come forward at the time of the Budget with a proposal eight days before you are due to report, will you put it in or not?
Robert Chote: We basically say that we cannot guarantee to put things in after an agreed deadline, which was the 21st.
Q239 Chair: Which is how many days?
Robert Chote: It was the 29th, so eight.
Q240 Chair: You guarantee that if it is with you for more than eight days, rather than 14, which was the case before, you will put it in. We got to the answer-we have moved from 14 to eight, plus some flexibility beyond eight.
Robert Chote: Exactly, so if they tell us the broad substance of a policy, but the details move afterwards, you can-
Q241 Chair: Okay. When were you told about the infrastructure plan?
Robert Chote: As I said, that was not brought to us in the run-up to the statement.
Q242 Chair: You were not aware of this at all, so it came to you as a bolt from the blue.
Robert Chote: As I said, we knew only what we read about in the newspapers.
Q243 Chair: You read about it in the newspapers?
Steve Nickell: Yes.
Q244 John Thurso: Mr Parker, you have had a quiet morning, may I address you? You collectively make the point that since the March forecast, the ONS has made some methodological changes and that "the data revisions suggest that the economy was growing more strongly in the run-up to the…crisis…the recession was deeper...slightly shorter…and the recovery…was stronger." What should we take from that, or is it just an interesting little piece of methodology and mathematics that has no future relevance?
Graham Parker: Some of what the ONS did had future relevance. In fact, some of the changes were on the way it calculates deflation, and it moved more to using CPI components rather than RPI. That does have a long-lasting impact, because it means that for any given nominal money GDP, more will be real growth and less will be inflation. As for the rest, I don’t know-my colleagues may have something to add.
Robert Chote: There were changes in, for example, relative size of profits in some of the revision, which would give us more insights into how some of the tax receipts had moved. One of the important things that underlines this is how much these numbers can move well after the out-turn data are there. I gave an example earlier: we now think the 1990s recession was roughly 40% shallower than it appeared in the first set of Blue Book data that came out after it.
Q245 John Thurso: What I am driving at is, what does that mean for us? Is this just a wonderful exercise in academia, or does the recession having been deeper, the boom preceding it boomier and the recovery therefore greater, actually have a policy impact? Is there anything in this that is of importance for policy makers or is it a neat piece of economic history?
Robert Chote: If you drill down into the make-up-how the different components of GDP have moved in order to end up with those sorts of aggregate changes-two of the puzzles that it did help to resolve, which we would have discussed at previous sessions, is why export growth did not appear to have picked up more in response to the weakness of sterling since 2007, and why the saving ratio was as low as it appeared to be as a consequence, despite the recession.
Both of those two puzzles have been partially resolved. The saving ratio has been revised significantly higher, and the ONS has also revised up exports and the contribution from net trade that has taken place in the actual data. The puzzle that it did not resolve and indeed slightly deepened is the one that we were all talking about earlier, which is the performance of productivity.
Q246 John Thurso: You also state that, "We do not believe there is sufficient evidence at this point to suppose that the financial crisis has led to a permanent reduction in the long-term potential rate of growth of the economy in the UK." How do you reach that conclusion?
Robert Chote: As we were discussing earlier, I think the sorts of effects that the financial crisis might have had in getting in the way of the reallocation of capital from inefficient to relatively productive projects, is the sort of thing that is likely to affect trend growth for a while. Therefore, because it does so for a while, it shifts down the level of future expected potential GDP from what you would have anticipated had the pre-crisis trends just continued on and on. That said, it does not seem that those sorts of effects would lead you to believe that, over the next 20 or 30 years, the growth rate of the economy is now likely to be less than was previously estimated. The change there is this methodological one that Graham has just mentioned, where for a given performance of the economy, statistically more of it is likely to show up as real growth and less of it as whole-economy inflation, than would previously have been the case.
Q247 John Thurso: For someone who is not a trained economist, is that real?
Steve Nickell: Real real.
Q248 John Thurso: As in, actually I can bank it, as it were.
Robert Chote: No. It is not telling you that we are now more optimistic about the underlying volume of goods and services that is going to be produced. It is just that more of it will show up in terms of what the ONS would describe as a real increase in output.
Q249 John Thurso: So no need to break out the champagne there then. May I ask you one last question that fascinated me? Going through your presentation, there is one page on "Policy Fiscal Risks". I think that is all there is on policy fiscal risks in the entire paper. The two biggies are the Government’s plans to take on Royal Mail’s historic pension and the UK and Switzerland tax evasion deal. Are those seriously the two greatest policy fiscal risks you can come up with? What is the point of that slide?
Robert Chote: What we are talking about are policies that have been announced, but where the detail of the timing and the way that they will be implemented are not yet clear enough for us to include them in the report. There are clearly many other risks that could happen to policy. These are things that we think are likely to affect our future projections, but that we do not yet know, for example, whether the Post Office deal is going to get state aid approval or not. So, it will either be in or out, and that might have an effect.
Q250 John Thurso: There are huge things such as what is happening to debt and Government employment-400,000 to 700,000-and there is this little number about the Royal Mail pension and the Swiss tax deal. I wondered about this. You are usually so wonderful on these things. I thought: what is this? Where is the hidden agenda in this?
Robert Chote: No, it dates back to the charter for budget responsibility, which says that we should include things in the central forecast when the details are robust enough to say what impact they will have in each and every year-
Q251 John Thurso: So these are the things you just need more detail on.
Robert Chote: But where policy is not yet in that state, the OBR should refer to these and deal with them as specific fiscal risks.
Q252 John Thurso: Could I suggest 6-point type and half a page in future, so it does not look out of context.
Robert Chote: You say these are small issues. I think, on the Royal Mail one, the fact that in the year that that happens that could knock down public sector net borrowing by £25 billion is quite useful to have flagged up, in advance of its coming as something of a surprise to people when it actually turns up.
Q253 Chair: Rather like your rather curious treatment, if I may say so, of PFI, on which we have had a good number of exchanges.
Robert Chote: You may say so: I think it is consistent with the same approach.
John Thurso: I couldn’t possibly comment.
Q254 Chair: In the past, you have said that you would rather steer clear of getting involved, in any way at all, in providing some kind of objective costing of Opposition policies at the time of elections-or, at least, of giving Opposition parties an opportunity to come to you for advice. Is that still your position?
Robert Chote: My position was the opposite. When we were having the discussion at the time of the-
Q255 Chair: You were supportive in principle, and then you came off that when the Government decided they did not like the idea.
Robert Chote: I said that Parliament needed to tell us very clearly, one way or the other, whether it wanted us to do that job or not, and not leave it up to us to make the inherently political decision of whether to do so.
Q256 Chair: Okay, I see. What is your position now?
Robert Chote: The position now, I think, is that this would be a very good question to address at the five-year review which you and others will be undertaking. I think it is perfectly reasonable to ask the OBR to establish a reputation on the mandate that we have at the moment before extending it in that sort of way. But in the long term, if you look at our Dutch counterparts, for example, that can be valuable for other parties and it can also add to the robustness of public debate and the robustness of policy, so I hope it is something that you will consider inflicting on my successor.
Q257 Chair: Speaking personally, that is my view, too, as it happens.
Thank you very much, indeed, all three of you for coming in this morning. You have heard some scepticism-you would expect that-but it may or may not be reflected in what we report. Thank you.
Robert Chote: Thank you very much.