*This was written in November, published today only with a change in tense to reflect these are comments on the OBR’s previous forecast and not what will be revealed later this week. In short, be cautious about the headlines that surround the OBR’s medium-term forecasts.*
With Sunak’s Spring Budget later this week, and associated Office for Budget Responsibility’s (OBR) forecast update, it’s worth recalling some key judgments from Autumn.
Indeed, the OBR’s flagship Economic and Fiscal Outlook publication, an update on the UK public accounts, is perhaps the most important macroeconomic update on the UK economy—providing more information on macroeconomic prospects than the lacklustre Monetary Policy Reports provided by the Bank of England (which doesn’t even contain a balance of payments forecast.)
And the OBR’s November update was noteworthy for the downward revisions to GDP resulting from the COVID-19 pandemic, as shown in Figure 1 and reported widely in the financial press. The impact of the pandemic was expected to be long-lived. In short, the OBR’s “central scenario” for the UK economy saw a cumulative shortfall of real activity over the 5 years from 2020-24 of 34 percent of one year’s GDP—that is, compared with previous March baseline. Moreover, the OBR projected GDP to be 3 percent lower in perpetuity once the economy “recovers.” And this baseline assumed of Brexit that “a deal is reached.”
But what lies beneath these forecasts? The benefit of the OBR’s forecasting round is their provision of spreadsheets and detailed projections of sector balances, balance sheets, GDP decomposition, and labour market statistics. And yes, a balance of payments forecast—or current account at least.
A complete review of their November forecasts would be a lengthy exercise, but to get a sense of these revisions Figure 2 shows the level of projected real exports and imports of goods and services. Even in March real exports were projected to decline to 2 percent below the average of 2018Q4-2019Q3 by 2025Q1 (2019Q4 being exceptional due to No Deal Brexit preparations.) Real imports, by contrast, were expected to grow 0.4% during this time. So, there was some differential external performance built in, and weak exports in particular.
But the revised forecasts by the OBR now imply real exports and imports only recover part-way from the COVID-19 shock, then exports begin to rollover; there was expected to be a permanent imprint on UK external trade volumes.
By 2025Q1, real exports of goods and services were projected to be 6.9% below the 2018Q4-2019Q3 average; imports 5 percent lower. Recall, this does not include any further impact from Brexit. The OBR has permanently revised down the UK’s trading prospects on the basis of COVID-19.
One cross-check on this pessimism is provided by the goods and service trade volume forecasts that underpinned the latest IMF World Economic Outlook. And there we discover that world trade volumes are expected to exceed the 2019 levels in 2022, and to be 14 percent higher by 2025. For emerging and developing markets, volumes are expected to exceed 2019 levels already in 2021.
So, the OBR forecast of no volume recovery contrasted with IMF optimism that global trade will recover. Moreover, the IMF’s own forecasts for UK trade, while admittedly lagging the rest of the G7, at least show recovery of volumes by 2025.
And this external weakness at the OBR was folded into a current account projection that sees the UK’s goods and service deficit weaken to 2.8 percent of GDP while the current account deficit, despite smaller net external transfers, settled at 5.0 percent of GDP. The real exchange rate adjustment since the 2016 Brexit vote had no impact on the external balance.
What should we make of the OBR’s external pessimism last November? It is possible that overarching concern about post-Brexit trade relations were weighing here, that COVID-19 provided an excuse to weigh more generally on the outlook. This is not to say Brexit won’t push a stick into the spokes of UK trade with the EU. It will, and it is, and possibly painfully in the next 6 months. But distinguishing short-term disruption from long-term secular changes is difficult. And if the global economy is supported by a post-COVID tailwind, as stronger household balance sheets underpin spending, these forecasts could still be found wanting very quickly.
More generally, given the tone in discussion of public finances that has emerged due to these forecasts—note the FT’s “Gruesome UK forecasts lay bare cost of coronavirus crisis”—we ought to be careful not to abuse such glorified guesswork. Macroeconomic forecasting can mislead as much as enlighten. Excess post-GFC forecast optimism that turned out to be misplaced could result in equally misplaced post-COVID pessimism.
Still, I much prefer the OBR’s macroeconomic transparency to the Bank of England’s opacity.