Image: Foreign and Commonwealth Office Image: Foreign and Commonwealth Office

When the Chancellor revealed his budget yesterday, he based his plans on assumptions made by the Office of Budget Responsibility. But were those assumptions credible?

The Office of Budget Responsibility – or OBR – assumed that the UK economy would grow faster than expected this year, slower than expected next year

201720182019
Forecast last NovemberForecast in Spring budgetForecast last NovemberForecast in Spring budgetForecast last NovemberForecast in Spring budget
OBR forecasts for growth in per cent1.42.01.71.62.11.7
In short, the OBR has changed its mind about when Brexit will hit the UK economy, but has not changed its mind on the extent of the hit.

As Capital Economics put it: “The economy’s recent resilience had fuelled expectations that public borrowing would fall back substantially, handing the Chancellor a sizeable “war chest” with which to protect the economy from Brexit uncertainties. But while the OBR raised its near-term growth forecasts, it judged that the negative impact of Brexit has been delayed, rather than diminished.”

And that takes us to the first problem. The global economy is looking good, at the moment. A recent purchasing managers index tracking global manufacturing rose to a 69-month high.

Truth is, the UK is doing better than expected because the global economy is doing better than expected, but the OBR does not seem to be able to see beyond the Brexit effect.

As a result, the OBR has forecast that public sector net debt will be slightly less than previously forecast by 2021/22, but that the public sector net borrowing requirement will be slightly higher.

And so, based on these assumptions, the chancellor revealed a cautious budget. Sure, he is spending some money on the digital transformation of the UK economy – funding more PhD students, for example, but such spending is simply inadequate.

To prepare for post Brexit, the UK needs a lot more – much better infrastructure, much more spending on creating digital skills within the work force, instead the chancellor is talking trifling sums.

The OBR’s forecast for inflation, by the way, was very odd. It is assuming that inflation remains below three per cent, and will outstrip wage increases. Very few economists agree.

Samuel Tombs at Pantheon Macroeconomics said “The OBR expects GDP to rise by 1 per cent more than the consensus over the next three years. This is partly because it thinks inflation will increase only modestly, ensuring real wages keep rising. It expects CPI inflation to average just 2.4 per cent this year and 2.3 per cent in 2019. By contrast, the MPC expects inflation to rise to 2.7 per cent in 2017 and 2.6 per cent in 2018, and we expect it to hit 3 per cent and 2.8 per cent respectively. In addition, the OBR is implicitly assuming a soft Brexit; the intensity of exports and immigration flows are assumed to fall gradually from 2019, rather than falling sharply as they might in a hard Brexit scenario.”

And on the topic of spending and government debt he said “On the face of it, the increase in cyclically-adjusted borrowing to 3.2 per cent in 2017/18 from 2.6 per cent in 2016/17 suggests that fiscal policy will boost the economy this year. Unfortunately, though, appearances are deceptive. Cyclically-adjusted borrowing will rise in 2017/18 primarily because contributions to the EU’s budget have been unusually low this year and central government debt interest payments are projected to increase to 2.0 per cent of GDP, from 1.8 per cent in 2016/17. Make no mistake, fiscal policy still will dampen the economy over the next year.”

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