Why good news for GDP isn't necessarily good news for the Chancellor

The output gap is a strange and unpredictable beast, writes Nida Broughton.

The Coalition came into Government in 2010 with a plan to repair the public finances and set itself a target to eliminate the structural deficit. The ONS today published figures showing that GDP in the second quarter of this year is even higher than we thought, rising by 0.7 per cent rather than 0.6 per cent. But it isn’t clear if this is good or bad news for the Chancellor’s deficit strategy, because the structural deficit – and therefore the billions of cuts that George Osborne is pencilling in – is determined by small changes in a very slippery measure of the state of the economy: the output gap.

The Government’s structural deficit target is carefully worded to take into account the fact that part of the deficit – the “cyclical” part – will automatically disappear as the economy recovers. From a theoretical point of view, this makes sense: there is little point on focusing efforts on areas of spending that are going to fall anyway. The non-cyclical, “structural” part of the deficit – the part that will remain even when the economy is back on track is surely the part to be concerned about. 

So since 2010, the Office for Budget Responsibility (OBR), whose remit is to report on Government’s performance against its fiscal targets, has set about trying to measure the “output gap” – a measure of how far the economy has to recover.  The output gap is the difference between actual GDP and “potential” GDP. Potential GDP is the level of GDP that the economy could achieve if it were operating at “full capacity”.

But it has become increasingly clear that in practice, the output gap is just too difficult to measure. The OBR’s twice-yearly reports always show a comparison of the OBR’s estimate of the output gap against those made by other forecasters – including banks and independent forecasting houses. This provides a useful sense-check of the OBR’s figures. 

The last OBR report in March, showed, as it always has done, the huge range that different forecasters have come up with in measuring the output gap – ranging from -7.3 per cent to -0.9 per cent for 2013. To put this into context, just a two percentage point difference in the output gap estimate is enough to change the forecast structural deficit in the Government’s target year of 2018 by around £28bn – no small amount when the Government is looking to cut around £33bn after the election.

Earlier this month, the Bank of England, searching for a way to measure the state of the economy as part of its Forward Guidance, decided against the output gap, saying that:

“The output gap is unobservable and difficult to explain, and any estimate would be subject to substantial uncertainty.”

Instead, it plumped for unemployment as a measure. And now even as the economy is showing some signs of life, independent forecasters still can’t agree among themselves on what the positive growth figures mean for the output gap, as shown in the chart below. Of those releasing estimates after July’s surprise good news on growth from the ONS, two thought this meant the economy was now closer to potential. One thought that it was now further away – presumably taking the good news on GDP to be a sign of underlying productivity improvements that mean that the economy’s potential has expanded. And two kept their output gap estimate unchanged. 

Chart: Forecasts of the output gap in 2013

HM Treasury, Forecasts for the UK economy: a comparison of independent forecasts, August 2013

The question has to be asked: how useful is a public spending target that depends on such an uncertain measure of the economy? Perhaps recognising this, or perhaps because it made for a better statistic, George Osborne omitted to mention the “structural deficit” at all in his last Spending Review speech in June, referring instead to the overall deficit. And even though the structural deficit – on OBR forecasts - is due to go into surplus by 2016-17, George Osborne’s planned cuts stretch out to 2018. So does the Chancellor himself still believe in the usefulness of his target?

The Chancellor. Photograph: Getty Images

Nida Broughton is Senior Economist at the Social Market Foundation.

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The real question about George Osborne and the Evening Standard? Why he'd even want the job

The week in the media, from Osborne’s irrelevant editorship to the unrepentant McGuinness and Vera Lynn’s stirring ballads.

The big puzzle about George Osborne’s appointment as the editor of the London Evening Standard is why he wanted the job. The Standard is now just a local freesheet, a pale shadow of its old self. In Tube carriages, discarded copies far exceed those being read. Its columnists are lightweight [Ed: as an occasional columnist myself, thanks, Peter] and its news stale, mostly written the previous day. Critics of Osborne’s appointment describe the Standard as “a major newspaper”. It is no such thing. The idea that the editorship will allow the former chancellor to propel himself towards the London mayoralty is laughable. In last year’s election for mayor, the Standard, according to University of London research, ran twice as many positive headlines about the Tories’ Zac Goldsmith as it did about Labour’s Sadiq Khan. The latter won comfortably. The paper was so supportive of Khan’s predecessor, Boris Johnson, that it became known as “the Daily Boris”. But Johnson, with a high profile from television, hardly needed its backing to beat a tired and largely discredited Ken Livingstone.

If Osborne believes that the Standard offers him a significant political platform, it is just further proof that he belongs to an ignorant elite.

 

Violent legacy

More than anyone else, Martin McGuinness, who has died aged 66, represented how the IRA-Sinn Fein combined uncompromising violence with negotiating charm to achieve its aims. Unlike Gerry Adams, McGuinness admitted openly and proudly that he was a senior IRA commander. In Londonderry on Bloody Sunday in 1972 he carried a sub-machine gun, but apparently without using it. Later that year, he was among a delegation that held secret talks with British ministers and officials. The following year, he was arrested near a car containing prodigious quantities of explosives and ammunition.

Like many who recall the IRA’s campaign in mainland Britain – three huge bombs detonated less than half a mile from me – I could never quite accept McGuinness as a government minister and man of peace. Whatever he said, he did not renounce ­violence. He just had no further use for it, a decision that was reversible.

 

A peace of sorts

When I hear politicians saying they could never contemplate talks with al-Qaeda, I smile. They said the same about the IRA. The idea of negotiation, John Major said, “turns my stomach”. A month later, news leaked of secret talks that would lead to a ceasefire. You can call it hypocrisy but politicians have no practical alternative. Significant terrorist campaigns rarely end without deals of some sort. Even then, dishonesty is necessary. The parties to the Good Friday Agreement with Sinn Fein in 1998 never admitted the true terms, perhaps even to themselves. In return for a role in government, the IRA ceased attacks on the British mainland, army, governing classes and commercial interests. It remained in control of working-class Catholic enclaves in Northern Ireland, where it continued to murder, inflict punishment beatings and run protection rackets. Not a pretty bargain, but it brought peace of a sort.

 

Real war anthems

“We’ll Meet Again” and “The White Cliffs of Dover”, sung by Dame Vera Lynn, who has just celebrated her 100th birthday, are the songs most closely associated with the Second World War. This, when you think about it, is peculiar. Most wars are associated with stirring, patriotic anthems, not sentimental ballads. Even the First World War’s “Keep the Home Fires Burning”, before it mentions hearts yearning for home, stresses the noble, manly instincts that drove soldiers to fight: “They were summoned from the hillside/They were called in from the glen,/And the country found them ready/At the stirring call for men.” Lynn’s songs had only the wistful sadnesses of parting and reassurances that nothing would change.

Their “slushy” tone troubled the BBC. It feared they would weaken the troops’ fighting spirit. Despite Lynn’s high ratings among listeners at home and service personnel overseas, her radio series was dropped in favour of more virile programmes featuring marching songs. Unable to sing to her forces fans over the airwaves, Lynn bravely travelled to the army camps in Burma. A BBC centenary tribute showed veterans of the war against Japan weeping as her songs were played back.

The wartime role of this unassuming plumber’s daughter makes me – and, I suspect, millions of others – feel prouder to be British than any military anthem could.

 

Ham-fisted attempt

After his failed attempt to increase National Insurance contributions for the self-employed, Philip Hammond, it is said, will have a £2bn hole in his budget. It will be more than that. Thanks to the publicity, tens of thousands more workers in regular employment will be aware of the tax advantages of self-employed status and hasten to rearrange their affairs. Likewise, newspaper accountants of old, after circulating memos imploring journalists to reduce lavish claims for “subsistence” while covering stories away from the office, would find a sharp rise in claims from hacks previously unaware that such a perk existed.

 

Battle of Hastings

My fellow journalist Max Hastings, attending a West End play, was once dragged on stage by the comedian James Corden, told to help move a heavy trunk and slapped on the bottom. Ever since, I have approached plays starring comedians warily. I dropped my guard, however, when I bought tickets for a contemporary adaptation of Molière’s The Miser starring Griff Rhys Jones, and found myself drenched when Jones spilled (deliberately) what purported to be fine wine. It was of course only water and, unlike
Hastings, I shall not demand a refund.

Peter Wilby was editor of the Independent on Sunday from 1995 to 1996 and of the New Statesman from 1998 to 2005. He writes the weekly First Thoughts column for the NS.

This article first appeared in the 23 March 2017 issue of the New Statesman, Trump's permanent revolution