Prime Minister rebuked by watchdog over growth claims

It was a speech characterised by a single phrase: "there is no alternative". Yesterday the Prime Minister set out to announce "clearly and plainly" that the UK's economic course would not be altered.

It came after an essay published in the New Statesman by the Business Secretary, Vince Cable, which suggested borrowing more to finance capital spending was an option that might revive flagging economic growth help to tackle the structural deficit - although not without risks.

If getting the better of yesterday's headlines wasn't hard enough, David Cameron will have a similarly difficult time today after Robert Chote, Chairman of the Office for Budget Responsibility (OBR) rebuked the PM over claims he made in the speech about the impact of austerity on UK growth.

In his letter Mr Chote cites an extract from the PM's speech yesterday, where Mr Cameron said:

"As the independent Office for Budget Responsibility has made clear, growth has been depressed by the financial crisis, the problems in the Eurozone and a 60 per cent rise in oil prices between August 2010 and April 2011. They are absolutely clear that the deficit reduction plan is not responsible. In fact, quite the opposite."

In fact, the OBR was far from absolutely clear about this. Mr Chote went on:

"For the avoidance of doubt, I think it is important to point out that every forecast published by the OBR since the June 2010 Budget has incorporated the widely held assumption that tax increases and spending cuts reduce economic growth in the short term."

In other words, the Government's policy of fiscal consolidation is likely to have reduced growth over recent years.

The apparent confusion seems to have been caused following the OBR's publication of its Forecast Evaluation Report in October last year, in which they set out to answer why they had significantly over-estimated the pace of economic growth since the autumn of 2010.

The report concluded that factors such as external inflation shocks, deteriorating export markets and difficulties in the Eurozone were "more likely explanations" for their over-estimates than the fiscal consolidation measures imparted by the Coalition.

It seems likely then that the Prime Minister's comments yesterday were intended to refer specifically to the reasons why recent economic forecasts have turned out to be overly-optimistic. Even here however, the OBR don't rule out the austerity programme as a factor, and merely emphasises external factors as being more likely causes.

The final paragraph of Robert Chote's letter summarises the OBR's position:

"To summarise, we believe that fiscal consolidation measures have reduced economic growth over the past couple of years, but we are not yet persuaded that they have done so by more than the multipliers we use would suggest."

It's unusual to see a letter like this drafted in response to a claim made publicly by the Prime Minister, but it's a good sign that the independent OBR are willing to set the record straight when it feels the facts aren't being represented as best as they could be. We hope the Prime Minister will be as willing to clarify his remarks in future.

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FULL TEXT OF CHOTE LETTER

Dear Prime Minister

I note that you said in your speech on the economy yesterday:

"As the independent Office for Budget Responsibility has made clear, growth has been depressed by the financial crisis, the problems in the Eurozone and a 60 per cent rise in oil prices between August 2010 and April 2011. They are absolutely clear that the deficit reduction plan is not responsible. In fact, quite the opposite."

For the avoidance of doubt, I think it is important to point out that every forecast published by the OBR since the June 2010 Budget has incorporated the widely held assumption that tax increases and spending cuts reduce economic growth in the short term.

To date our forecasts have used 'multipliers' that imply that every £100 of fiscal consolidation measures reduce GDP in that year by around £100 for capital spending cuts, £60 for welfare and public services cuts, £35 for increases in the VAT rate and £30 for income tax and National Insurance increases, with the impact diminishing thereafter. As we discussed in our October 2012 Forecast Evaluation Report, applying these multipliers to the consolidation measures put in place by the previous and current governments would have been sufficient to reduce GDP in 2011-12 by around 1.4 per cent.

Needless to say, there is huge uncertainty around multiplier estimates. Over recent months the International Monetary Fund alone has published a variety of estimates for industrial countries, some larger, some smaller and some broadly in line with those we have used to date. We have chosen estimates from within the wide range in the academic literature.

Economic growth has been much weaker since the end of 2010 than we and most other forecasters expected in June 2010 and it is clearly possible that this is in part because the fiscal consolidation measures have had a greater 'multiplier' effect than we anticipated. But, in the Forecast Evaluation Report, we concluded from an examination of the subsequent outturn data that the impact of external inflation shocks, deteriorating export markets, and financial sector and eurozone difficulties were more likely explnanations.

To summarise, we believe that fiscal consolidation measures have reduced economic growth over the past couple of years, but we are not yet persuaded that they have done so by more than the multipliers we use would suggest.