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.

Photo: Getty
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Tim Shipman's Diary

The Sunday Times political editor on poker, pasta – and being called fat by Andrew Marr.

A couple of Saturdays ago, I was having dinner with my wife at Padella (which serves the best pasta in London) when the phone rang. It was an irate David Davis. “You’re reporting that a friend of mine has said Philip May wants Theresa to quit. It’s not true. I don’t even know Philip May.” I calmly explained that I wasn’t accusing him and I had his friend on tape. “Who was it?” he asked me. I wasn’t saying. “Well, it’s not bloody helpful,” the Brexit Secretary said before hanging up.

The following day, I woke up to watch Philip Hammond explain to the BBC’s Andrew Marr why his cabinet colleagues had leaked me details of how the Chancellor had branded public-sector workers as “overpaid”. “I don’t know who [Tim Shipman’s] sources are,” he said, after inaccurately suggesting that I was being fed information as part of some Brexiteer conspiracy to discredit the cabinet’s leading Remainer.

On Monday, I did an interview with Eddie Mair in the back of a beer garden in Ireland, where I’m playing cricket. In reality, the leaks had much more to do with colleagues irritated at Hammond’s sometimes grating behaviour. Word reaches me that he regards it all as very unhelpful. It seems odd after 16 years in political journalism to have to say this, but we’re not here to be helpful. It might make sense if our politicians gave us less to write about. Over the past three years, they have delighted us enough.

Back for seconds

Voter fatigue is a recognised problem. No one talks about journalist fatigue. We all hope that Theresa May rejuvenates on her Swiss walk (perhaps regenerating into Jodie Whittaker). Thanks to the decision she took when she last went walking, I’m facing the obliteration of another summer holiday writing a second political tome covering the period since my Brexit book, All Out War, up to the general election. What looked at one stage like the boring second album is now a rip-roaring tale of hubris and nemesis. When I asked for title suggestions on Twitter, there were plenty of votes for “Mayhem” and “Mayday”. The most imaginative was: “The Snarling Duds of May”. Sadly, it’s too long for my publisher.

Catching the big fish

The new-found attention from writing books is a double-edged sword. To my delight, then embarrassment, Andrew Marr referred to me twice as “the doyen” of the print lobby. “We keep trying to stop him,” Marr’s editor, the redoubtable Rob Burley, confided at a rival magazine’s summer party. The following week, Marr said: “The biggest fish in the pool, if only physically, is Tim Shipman…” I got a text from a special adviser friend asking: “Are you paying him?” I pointed out that Britain’s best-known political interviewer had just called me a fat bastard live on national television.

New blood

I make my debut on BBC2’s Newsnight alongside Ash Sarkar of Novara Media, one of the new websites that cheerlead for Jeremy Corbyn. She is nerveless and fluent in her mid-twenties, when I was a tongue-tied naif. People who get the Corbyn phenomenon are rightly getting more airtime. Off the air, she tells me that she’s a “libertarian anarchist” and then asks me where I live. “Are you going to smash it up?” I ask nervously. She smiles. Ash’s main concern is to paint the town red in the Saturday-night sense. A Labour MP draws attention to her Twitter biog, which concludes: “Walks like a supermodel. Fucks like a champion. Luxury communism now!” Bravo. I think…

Brexit gamble

I was greatly cheered by the induction in the Poker Hall of Fame of the late Dave “Devil­fish” Ulliott, the player who did the most to create the TV and online poker boom in Britain. Westminster has a few useful card sharps – Paul Stephenson, formerly of Vote Leave, among them – but I don’t know any politicians who play. By contrast, the US presidents Harry Truman, Dwight Eisenhower, Lyndon Johnson and Richard Nixon were all accomplished poker players.

When I worked in the US, I interviewed a member of Barack Obama’s poker circle when he was a state senator in Chicago. The cautious, composed and occasionally bold player he described was the mirror image of the politician we came to know. His Republican rival in 2008, John McCain, preferred the chaotic gambling of the craps table and his erratic campaign reflected that. Too many of the current cabinet seem to be dice men. What we wouldn’t give for Devilfish running the Brexit negotiations.

Blundering through

Anyone who has ever dealt with McCain would have been saddened by the news that he is suffering from brain cancer, but his resilience almost makes you feel sorry for the tumour. McCain is undoubtedly the most media-friendly politician I have ever met. When I travelled on his plane in 2008, he took every question from the foreign press pack and made us feel welcome. Through him, I also met Steve Duprey, the former boss of the New Hampshire Republicans. He was fond of explaining Duprey’s first law: “In politics, before considering malevolence, always assume incompetence.” I have had much cause to remind myself of that over the past three years.

Paranoid android

If you are looking for a summer read, I recommend Jonathan Allen’s and Amie Parnes’s Shattered, a great insider account of Hillary Clinton’s disastrous 2016 presidential election effort. It shows how a flawed candidate with little ability to connect with the public presided over a paranoid regime of advisers engaged in Shakespearean bloodletting that led to them coming a cropper when fighting a charismatic populist. On second thoughts, you could always wait to read my second book this autumn. 

Tim Shipman is the political editor of the Sunday Times. “All Out War” is now available in paperback (William Collins)

This article first appeared in the 27 July 2017 issue of the New Statesman, Summer double issue