Economic and fiscal outlookNovember 2011

Robert ChoteChairman

Coverage and process

• Five year forecasts for the economy and public finances, plus assessment of progress against targets

• Independent Budget Responsibility Committee responsible for assumptions, judgements and conclusions

• No political or official pressure to change them

• BRC helped by OBR staff and drawing upon expertise in many Whitehall departments and other bodies

Overview• Growth in 2011 weaker than expected thanks to inflation squeeze

• GDP to grow by 0.9% in 2011 and 0.7% in 2012

• Medium term growth prospects also weaker

• Economy expected to be 3½% smaller by 2016 than thought in March

• Weaker growth means more borrowing – and structural not cyclical

• Without additional action, fiscal targets likely to be missed

• Government announces extra spending cuts in 2015-16 and 2016-17

• Targets back on course to be hit, but with smaller margin than March

How much spare capacity?

-5

-4

-3

-2

-1

0

1

2

3

Q12007

Q3 Q12008

Q3 Q12009

Q3 Q12010

Q3 Q12011

Q3

Per ce

nt

"Aggregate composite" estimates"Principal components analysis" estimates (previous approach)"Principal components analysis" estimates (updated approach)

Output gap c. 2.5% in Q3

Weak growth in potential output

• Output gap smaller in Q3 than at end-2010 and than expected in March

• Would have been much wider if potential output had been growing as strongly as we assumed at Budget time

• Productive potential appears to have grown 1% a year since recession

• Weak productivity growth rather than higher structural unemployment

Output per hour stays below pre-crisis trend

90

95

100

105

110

115

120

125

Q12003

Q12004

Q12005

Q12006

Q12007

Q12008

Q12009

Q12010

Q12011

Inde

x 100 =

Out

put p

er h

our in

2003Q

1

6.6%

Productivity grows less than in past recoveries

94

96

98

100

102

104

106

108

110

112

114

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Quarters after end of recession

Inde

x 10

0 =

Out

put p

er h

our in

fina

l qua

rter of

th

e re

cess

ion

1980s 1990s 2008-09

Potential output revised down

• Hard to fully explain weak productivity growth

• May be that financial sector problems are preventing firms from reallocating capital to more productive activities

• Now seems sensible to assume gradual rise in potential output growth rather than ‘snap back’ to long run average

• Potential output now expected to be 3½% lower in 2016 than expected in March

Potential output: comparing forecasts

98

100

102

104

106

108

110

112

114

2009 2010 2011 2012 2013 2014 2015 2016

Inde

x 10

0 =

Pot

entia

l out

put i

n 20

09

(Nov

embe

r 20

11 fo

reca

st)

November EFO IMF European Commission OECD

Monthly GDP growth since the Budget

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11

Perc

enta

ge p

oint

s

Production Services Construction Total

Quarterly GDP growth in the short term

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3

Perc

enta

ge c

hang

e on

pre

viou

s qu

arte

r

Annual GDP growth in the medium term

-5

-4

-3

-2

-1

0

1

2

3

4

5

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Perc

enta

ge c

hang

e on

pre

viou

s ye

ar

Level of GDP: forecast comparison

98

100

102

104

106

108

110

112

114

2009 2010 2011 2012 2013 2014

Inde

x 10

0 =

200

9Q2

November EFO March EFOBank of England (Nov) Average independent forecast (Nov)

Net trade contribution to GDP growth

0

1

2

3

4

5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Perc

enta

ge p

oint

s

November EFO March EFO

Household incomes and consumption

-4

-3

-2

-1

0

1

2

3

4

5

6

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Perc

enta

ge c

hang

e on

pre

viou

s ye

ar

Real consumption Real household disposable income

CPI inflation to fall next year

0

1

2

3

4

5

6

7

8

9

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Perc

enta

ge c

hang

e on

a y

ear

earli

er

Unemployment to rise into next year

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Thou

sand

s

ILO unemployment Claimant count

Effects of Autumn Statement measures • Spending cuts in 2015-16 and 2016-17

– Cut direct contribution to GDP growth from government consumption

– Assumed offset by looser monetary policy at that horizon

• Credit easing– No effect assumed in this forecast– Potential to boost investment and growth, but hard to judge

effectiveness until we have more details eg of contracts requiring pass-through

• Delayed fuel duty increases– Inflation forecast revised down modestly

• New build indemnity scheme– Modest increase in forecast for housing transactions

Potential risks from the euro area

• Central forecast assumes that euro area ‘struggles through’

• More disorderly outcome a significant downside risk

• Could affect UK through a number of channels– Weaker trade– Tighter credit– Government borrowing costs– Financial system impairment

• Cannot quantify downside risk in a meaningful way, given the range of potential outcomes

Headline deficit to shrink, but more slowly

0

2

4

6

8

10

12

2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Per ce

nt o

f GD

P

November EFO March EFO

Revenues lower and spending higher

• Revenue and spending impact roughly equal in 2015-16

• On the revenue side:– Lower wages and salaries, consumer spending and profits– Lower oil prices, share prices and interest rates – Sharp fall in financial sector corporation tax payments

• On the spending side – Departmental spending is mostly fixed in cash terms– Higher CPI inflation and claimant count unemployment– Offset by lower debt interest costs and spending cuts

Bigger squeeze on public services spending

Annual real change in implied PSCE in RDEL (non-investment spending on public services and admin)

-5

-4

-3

-2

-1

0

1

2

3

4

5

2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Perc

enta

ge c

hang

e on

pre

viou

s ye

ar

Spending Review

Student loans put upward pressure on debt• Average loan per student now estimated at

£7,000, up from £6,800 in March

• Lower earnings forecast reduces expected repayments

• Government pays out more and gets less back during the forecast period, putting modest upward pressure on debt

Debt peak higher than in March

50

55

60

65

70

75

80

2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Per

cent

of G

DP

March EFO November EFO (ex. policy) November EFO (inc. policy)

General government employment

• March forecast suggested 400,000 fall in GGE from 2011Q1 to 2016 Q1

• Bigger implied public services cuts raise estimate to 710,000 by 2017 Q1

• Greater uncertainty thanks to decision to recycle savings from pay restraint in schools and NHS

Policy fiscal risks

• The Government plans to take the Royal Mail’s historic pension deficit into the public sector, but this requires state aid approval.

– Impact would look strongly beneficial in the short term, but would likely be negative in the longer term

• The UK and Switzerland signed an anti tax evasion deal in August, but it has to be ratified by the Swiss parliament and may require a referendum.

– Ministers and HMRC have publicly stated that the agreement should yield £4 to 7 billion.

– We currently judge that the yield from the agreement is likely to be towards the lower end of the range

Meeting the mandate?

-3

-2

-1

0

1

2

3

2014-15 2015-16 2016-17

Per

cent

of G

DP

Autumn Statementmeasures

Budget spendingassumption

Other forecastingchanges

Judgement onpotential output

November EFO

March EFO

Meeting the mandate?

-3

-2

-1

0

1

2

3

2014-15 2015-16 2016-17

Per ce

nt o

f GD

P

Autumn Statementmeasures

Budget spendingassumption

Other forecastingchanges

Judgement onpotential output

November EFO

March EFO

Meeting the mandate?

-3

-2

-1

0

1

2

3

2014-15 2015-16 2016-17

Per

cent

of G

DP

Autumn Statementmeasures

Budget spendingassumption

Other forecastingchanges

Judgement onpotential output

November EFO

March EFO

Meeting the mandate?

-3

-2

-1

0

1

2

3

2014-15 2015-16 2016-17

Per

cent

of G

DP

Autumn Statementmeasures

Budget spendingassumption

Other forecastingchanges

Judgement onpotential output

November EFO

March EFO

Meeting the mandate?

-3

-2

-1

0

1

2

3

2014-15 2015-16 2016-17

Per

cent

of G

DP

Autumn Statementmeasures

Budget spendingassumption

Other forecastingchanges

Judgement onpotential output

November EFO

March EFO

Chances of meeting the mandate

-6

-5

-4

-3

-2

-1

0

1

2

3

4

2006-07 2008-09 2010-11 2012-13 2014-15 2016-17

Per ce

nt o

f GD

P

November central forecast

The supplementary target

• To have debt falling as a share of GDP in 2015-16

• March forecast: fall of 1.4% of GDP

• November forecast: fall of 0.3% of GDP

• Pre-measures forecast: increase of 0.2% of GDP

Sensitivity analysis

• Test how sensitive the public finance forecasts are to four parameters:– Size of the output gap– Pace of the recovery– Interest rates on government debt– Impact of the economic cycle

• Further downward revision to potential GDP the greatest danger

Scenario analysis

• Tests significance of key judgements

• Three scenarios – Persistent tight credit conditions: unhelpful– No structural hit from crisis: helpful– Higher structural unemployment, but growth

unaffected: little net impact

• Disorderly euro outcome hard to quantify