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Why the IMF could be forced to eat ‘humble pie’ again

IMF - Stephen Jaffe/IMF
IMF - Stephen Jaffe/IMF

They call it the "dismal science" for good reason. The supposed oracles of economic forecasting have been forced to eat humble pie on more than one occasion.

Christine Lagarde famously asked if she had to apologise “on my knees” to George Osborne after accusing the former chancellor of “playing with fire” on austerity. “We got it wrong. We acknowledged it,” the then International Monetary Fund managing director said in 2014.

That didn't stop Ms Lagarde from making the same mistake again. In fact, there are many examples of forecasters at the Washington-based International Monetary Fund missing the mark.

Its growth forecasts for the UK have differed significantly from the actual results in recent years.

Back in July, the Fund predicted the UK economy would grow by 3.2pc in 2022, an estimate it revised slightly higher to 3.6pc in October.

Yet on Tuesday, it judged the economy to have grown by 4.1pc, revealing it had been far too gloomy.

The disparities have been particularly stark in recent years, with the pandemic prompting huge sways in GDP.

Two and a half months or so before the UK’s first lockdown was announced, the forecasters tipped the economy to grow 1.4pc in 2020. A year later, they estimated it had in fact faced a 10pc contraction.

Some get it wrong so often that they actually publish annual post-mortems of their mistakes.

The Office for Budget Responsibility (OBR), the government's tax and spending watchdog, is one of them.

It published its latest mea culpa on Tuesday, admitting that its March 2021 forecast failed to spot stronger inflation and a more robust post-pandemic recovery that meant more people were in work and tax receipts and wage growth were higher than expected, dragging even more people into higher tax bands.

The forecast, which the watchdog helpfully unpicked in its latest Forecast Evaluation Report, highlights how small misjudgments can end up leading to big errors.

It said higher inflation, which boosted the cash size of the economy and as a result tax receipts, resulted in a "£108.6bn overestimate of borrowing in 2021-22". These are big numbers.

The OBR acknowledged that one big mistake it made was underestimating the strength of Britain's jobs market. Many, including the Bank of England believed that ending the furlough scheme that subsidised people's wages in 2021 would lead to hundreds of thousands more people losing their jobs.

That led to predictions of slower growth, higher unemployment and ultimately the Bank of England to delay raising interest rates, which many economists recognise today was a mistake.

One might forgive forecasters for failing to predict the full impact of a once-in-a-lifetime pandemic. But missing swings like recessions or strong growth spurs has been an issue for decades, although analysis has found forecasts are more likely to be overly optimistic.

So is this time different? The Fund singled out the UK as the only major economy it expects to shrink this year. Even Russia, which the international community is trying to ostracise from the rest of the world, is expected to eke out growth this year.

The late British economist Michael J. Artis observed already in the mid-1990s when doing an assessment for the Fund that it struggled to predict turning points.

Nearly three decades later another IMF working paper found that errors were “broadly proportional to the volatility of growth”. However, it observed the forecasts were getting more accurate over time.

In the case of the UK, there have been several misjudgments. Ms Lagarde warned before the Brexit vote that it could “lead to a technical recession”, meaning two straight quarters of the economy shrinking.

While she was not alone in making that assessment – Mark Carney who was governor of the Bank of England had made similar comments – such a downturn never materialised.

But do such wrong forecasts matter? Some economists believe they do – although more so when it’s the OBR, or the Bank of England that is wrong.

Economist Julian Jessop, who advised short-lived prime minister Liz Truss, said “very few people take any notice of what the IMF says in the business community or the financial markets”.

However, while he believes they are just regarded “as another forecaster”, their analysis can hold some sway with policy-makers. “That can be unhelpful,” he says.

“A good example of this was in the wake of the global financial crisis when the IMF came up with some estimates for what impact tighter fiscal policy might have on the economy. Those estimates suggested that austerity would have relatively limited effects on economic growth,” he says, adding: “Those numbers were taken very seriously by governments, including in the UK, and probably contributed to maybe a bit too much austerity.”

Another recent example of wrong forecasts having real-world impacts is the Bank of England’s failure to predict the surge in inflation, he says. It means interest rates were lower than they should have been for longer. Misjudgments by the OBR can also have such implications, he adds.

(L-R) Richard Hughes, David Miles CBE and Andy King of the Office for Budget Responsibility - Dan Kitwood/Getty Images
(L-R) Richard Hughes, David Miles CBE and Andy King of the Office for Budget Responsibility - Dan Kitwood/Getty Images

“If the OBR is predicting a deep recession and saying that the public finances will therefore be worse than they would otherwise have been, that might prompt the Chancellor to raise taxes and cut spending. Ironically, this might mean the forecasts are right for the wrong reason,” he says.

Douglas McWilliams, founder of the Centre for Economics and Business Research, echoes this sentiment. He says the OBR was too optimistic about inflation while recently it may now appear to be too pessimistic because of falling gas prices.

“Whether the OBR gets it right or wrong will affect the scope [the Chancellor] has for action. It's a slightly perverse thing because if the prospect is more optimistic, in theory, he appears to have more scope for tax cuts or for fiscal expansion. If the forecasts are more pessimistic, then he actually has to be a bit tighter, and that does run the risk of exacerbating the problems,” McWilliams says.

George Buckley, of Nomura, says that understanding “the story” and “what’s going on beneath the bonnet” is generally much more important than the exact accuracy of forecasts.

“It's always important to think about the narrative and think about what's going on and try to understand the economy but point forecasts are almost pointless,” he says before adding that it's perhaps an overstatement but one should certainly take them "with a big pinch of salt".

“There's always going to be some error in those forecasts. This has been said forever. Just look at the Bank of England forecasts and their fan charts. The fan charts are absolutely huge, indicating that this is where we think GDP is going to be, this is where we think inflation is going to be, but the likelihood is that it might fall anywhere between these ranges and possibly even outside.”