Forecasters have been much too pessimistic about Brexit

Posted on November 27, 2016

This year has not been kind to economic forecasters. Blood-curdling noises from the Treasury before the EU referendum were, thankfully, not fulfilled.

The Treasury had warned of an “immediate and profound shock to our economy” which “would push our economy into a recession and lead to an increase in unemployment of around 500,000” if there were a vote for Brexit. Much of the rest of the economics establishment, including the International Monetary Fund, fell in behind it with further pre-referendum prophecies of gloom. In the event, the economy grew a robust 0.5 per cent in the third quarter of 2016, business investment rose and the labour market remained firm.

Following the referendum, the Bank of England slashed its growth forecasts in August as justification for its arguably premature package of monetary easing. Granted, it modestly upgraded its projections in November, but doubts over the robustness of its forecasting practices persist.

The failure of the economy to react to the Brexit vote as anticipated has undeniably damaged the reputation of economic forecasting. And this has informed many responses to the Office for Budget Responsibility’s “Economic and fiscal outlook” that accompanied the Autumn Statement. Some observers have mocked the uselessness of “experts” in general, and economic forecasts in particular, and have dismissed the OBR’s painstaking work out of hand. Is this fair? Yes and no.

In the OBR’s defence, there is little doubt that the outlook is a thorough and politically impartial document. But the OBR knows as well as anyone that forecasts are uncertain at the best of times, and that they are especially uncertain in the current climate. We do not yet know, for example, what Britain’s relationship with the EU will be after departure. For the OBR, obliged to forecast growth and the public finances, this poses some substantial challenges. It does what it can.

In an especially illuminating piece of analysis, the OBR attempted to assess the specific impact of Brexit on public borrowing. Over the five-year period 2016-17 to 2020-21, it forecasted extra total borrowing of £122bn compared with its March forecast (an increase to more than £216bn). Based on selected variables, including lower growth rates and higher inflation, it concluded some £59bn could be attributed to the effects of Brexit.

The remaining £63bn was attributable to other sources, comprising official statistical classification changes (£12bn), non-Brexit forecasting changes (more than £25bn) and government policies including extra spending (£26bn). Suffice to say, lurid headlines following the Autumn Statement informed us that £59bn was the “cost of Brexit”. Some commentators, those who had failed to study annex B of the document, went so far as to claim that the cost of Brexit was £122bn.

But while this all sounds very impressive, we should treat the OBR’s crystal ball-gazing with a healthy dose of scepticism. Forecasts, even a year ahead, indicate little more than the general direction of travel, and five years out they are basically fiction. The OBR effectively acknowledges this by publishing growth “fan charts” which represent outcomes with varying probabilities based on past official forecasting errors.

While its central growth forecast is 1.4 per cent for 2017, the fan chart suggests that growth could be between roughly zero and roughly 3 per cent. So perhaps we should not worry too much about the OBR’s November downgrades and the forecast of Brexit’s £59bn “impact” on the public finances after all. They are almost certainly overly pessimistic. And while higher prices could slow consumer spending, the lower pound and lower interest rates will boost the economy. Growth should continue much as it would have done if there had been no Brexit vote at all.

The writer is economic adviser at Arbuthnot Banking Group

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