When Rachel Reeves glided into the Treasury last summer promising the most pro-growth exchequer “in our country’s history”, she could scarcely have imagined the predicament she’d be facing less than 18 months later.
With the election win fading from memory, the Chancellor is facing a bleak winter, with economists expecting another round of tax increases in the Budget to address an expected £50bn hole in the public finances.
One thing Reeves failed to mention in her maiden speech to Treasury staff as Chancellor was the country’s fiscal watchdog. The Office for Budget Responsibility (OBR) is widely believed to have contributed significantly to the fresh chasm in public finances with its downgrade to productivity forecasts.
Chaired by civil servant Richard Hughes, the OBR has become one of the most powerful forces in British politics in recent years. Because chancellors must use their work as the basis for their arithmetic, it holds enormous sway over nearly every facet of UK public spending.
But some now say the OBR’s own misfiring forecasts could be to blame for painting Reeves into a corner.
The scale of the OBR’s downgrade will not become known to the country until Reeves delivers her Budget on Nov 26, but even a small shift in the outlook has major consequences.
City stockbroker Panmure Liberum estimates that just a 0.1pc difference to the OBR’s productivity forecast would have a £9bn impact on the UK’s fiscal headroom by the end of the decade. Reeves only left herself £9.9bn of room for error in her spring statement back in March.
“The Chancellor has pinned herself into a very difficult position here, heavily reliant on whatever fiscal space the OBR is able to generate,” said Prof Jagjit Chadha, a lecturer at the University of Cambridge.
“I think that is, frankly, a cockamamie way to run fiscal policy. On the basis of a forecast of where the economy is going to be in a few years’ time, which we know is going to be wrong.”
Ever since its foundation, the OBR’s productivity growth forecasts have been characterised by one thing – overoptimism.
In the years after it was founded, the OBR consistently forecast that productivity would follow the same trend set before the financial crisis, with output growth estimated to come in between 2pc to 2.5pc.
By 2016, after consistently overshooting actual productivity growth, the watchdog began to temper its forecasts. Yet even these were too optimistic as shocks from Brexit, the pandemic, and the energy crisis weighed on growth.
Thomas Pugh, chief economist for RSM UK, said: “Essentially, the OBR has long assumed that productivity growth will eventually return to its historical average. This isn’t a particularly silly assumption in itself … But it has proven to be wrong so far.
“Recent productivity growth has been close to zero, so expecting it to return to 1pc a year looked ambitious.”
