Wednesday, 27 December 2017

Marking myself to market: my forecasts for 2017, evaluated

Every year the Financial Times asks, just before Christmas, 100-odd UK economists for their predictions for the year to come.  And in recent years, in the spirit of Brad Delong’s call for economists to “mark their beliefs to market”, I’ve looked back at what I said last year.  So here are my responses from December 2016 (the whole FT survey is here) with some ex post self-assessment.  

1. Economic prospects

How much, if at all, do you expect UK economic growth to slow in 2017? Please explain your answer.

I would expect it to slow somewhat in the first half of the year. What happens in the second half depends very much on developments with the Brexit negotiations (as well as events in the US and elsewhere in Europe). We could see reasonable if not spectacular growth, but downside risks are large

Assessment: Accurate. Growth did slow significantly in the first half of the year, but there was no recession.

2. Brexit

Compared to what you thought 12 months ago about the UK's long-term economic prospects outside the EU, are you now more optimistic or more pessimistic than you were?

Please explain your answer.

The strong consensus amongst economists is that Brexit will make the UK significantly worse off in the medium to long term - not disastrously so, but significantly. This is backed up by a considerable body of theoretical and empirical evidence. Of course, this evidence is based on historical data, and past is not necessarily prologue; there is a high degree of uncertainty. But the probability must be that Brexit will make us worse off. It is also important to note that while economic developments since the referendum have certainly not borne out the pessimistic forecasts of some institutions, that really tells us almost nothing about long-term impacts - short-term forecasts are made using very different methodologies to those used to estimate long-term impacts, and (paradoxically) are much less reliable.

Assessment: not much new evidence on this.  It still seems a reasonable assessment to me.

3. Inflation

Inflation has started to increase in recent months. To what extent do you expect inflation to rise in 2017?

If the exchange rate stays where it is to about 3%. However, if it falls a lot farther inflation could rise more (or conversely)

Assessment: Accurate. It is currently at 3.1%, which is likely to be the peak.

4. Monetary policy

In December, the Monetary Policy Committee said the next interest rate move could as easily be up as down. Will there be a shift in this monetary policy stance by the end of 2017? Please explain your answer.

It is difficult at the moment to see the next move being down, even if the economy worsens. Barring negative shocks (which are quite possible) I'd expect the next move to be up.

Assessment: Accurate.  The Bank of England raised interest rates in November.

5. Immigration

Immigration is likely to be central to the Brexit negotiations in 2017. How much do you think immigration will change and what effect do you think this will have on the UK economy?

My recent research suggested that EU migration to the UK could fall by well over half over the period from now to 2020, resulting in net EU migration falling by more than 100,000. Both the state of the economy and the existence of free movement of workers are significant determinants of migration flows. In particular, free movement with the UK results in an increase of almost 500% - that is, by a factor of six. It follows any significant restrictions on free movement will reduce those flows. I also used the existing empirical research on the impact of migration on productivity, growth and wages to estimate the broader economic impacts of such a reduction. Over the period to 2020, the resulting reduction in GDP would be about 0.7 to 1.3%, with a GDP per capita reduction of 0.3 to 0.8%. By contrast, the increase in low-skilled wages resulting from reduced migration is expected to be relatively modest.

Assessment: Accurate up to now. As I predicted, migration, especially from the EU, has already fallen substantially, even before any changes to free movement or immigration policy, and this is likely to be part of the reason growth has weakened. 

6. Fiscal policy

Philip Hammond is expecting government borrowing to fall in 2017. His new fiscal rules provide headroom for more borrowing than currently forecast. To what extent will he need to use it and why?

The OBR's fiscal forecasts look relatively pessimistic; however the economic ones may be too optimistic. Moreover, current spending plans for health and social care (and perhaps education) look unrealistic. The NHS is clearly significantly underfunded (it is basic economics that a richer, older society should, from the point of view of overall welfare or wellbeing, spend a greater proportion of GDP on health over time - the reverse has been the case over the past few years.) It is not clear that such spending increases should be financed by borrowing, but the government is unfortunately committed to a set of tax cuts that have little economic rationale and will mostly benefit the relatively better off. Some discretionary increase therefore seems likely.

Assessment: Accurate.  It has become abundantly clear (if it wasn’t already) that the NHS is underfunded, and, as I suspected, the government does not have the political will to raise taxes. There has therefore been some discretionary fiscal loosening, although current plans still look unrealistic and the current government is still intent on changes to the tax and benefit system that will redistribute from the poor to the better off.

7. Donald Trump

How do you think Donald Trump's presidency will affect the UK economy in 2017?

This is exceptionally uncertain, for obvious reasons. However, it does look likely that US interest rates may now begin to rise steadily. This will put some downward pressure on the pound and upward pressure on UK long-term rates, which may well be unwelcome.

Assessment: Mixed at best.  Interest rates have risen, but not steadily, and sterling has risen against the dollar rather than fallen over the year. Not particularly insightful (though I did say that it was highly uncertain).

Overall assessment: Broadly accurate. I got most things broadly right: growth, inflation, interest rates, fiscal policy, and – reassuringly, given that this was based on my research rather than just educated guessing – immigration.  Indeed, it’s notable that while lots of economists got individual things wrong, overall and on average we were pretty accurate, especially on the UK’s headline growth performance. I don’t think any of us said anything terribly useful about Trump, however, certainly not me.

Finally, since Patrick Minford, of Economists for Brexit, recently claimed, falsely, that I’d predicted a recession after the Brexit vote, it’s worth noting what he said last year: 
The Cardiff/Liverpool forecasting group does not expect a slowdown but rather that growth will continue in the 2-3% corridor of 2016.   The reasons are that a) the Brexit long run effect should be positive due to the opening up of free trade globally and the return of regulation to the UK from the EU, while we expect migration control to be exerted on unskilled labour where taxpayer costs are high, leaving skilled labour lin its current liberal regime. b) ‘uncertainty’ is mild, since it spans a range from a status quo ‘soft’ Brexit to a ‘clean’ Brexit with effects as in a)- uncertainty therefore about the upside.

More (even more embarrassing) detail here, via Chris Giles. 

The FT Economists survey for 2018 will be published early in the New Year.

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