Box sets » Potential output and the output gap

Chart 2C: Change in 16-to-64-year-old inactivity
Economic inactivity rose significantly following the pandemic. This box explored the factors behind this rise, including decomposing it into different age brackets and considering the reasons behind it, as well as analysing the flows into and out of inactivity.

Economy categories: Potential output, Labour market

In each Economic and fiscal outlook we publish a box that summarises the effects of the Government’s new policy measures on our economy forecast. These include the overall effect of the package of measures and any specific effects of individual measures that we deem to be sufficiently material to have wider indirect effects on the economy. In our November 2022 Economic and fiscal outlook, we adjusted our economy forecast to take into account plans for the energy price guarantee (EPG) and consider the impact of tax and spending measures on the supply side of the economy.

Economy categories: Potential output, Inflation, Labour market

Cross-cutting categories: Forecast process, Fiscal multipliers

Persistently higher energy prices can reduce the supply capacity of the economy. In this box, we use a production function to estimate the impact of higher fossil fuel prices on potential output.
The new immigration system
The Government announced plans for a new 'points based' immigration system set to come into place in 2021 that will align migration policy for EU and non-EU migrants. In this box, we considered the impacts of this new system on the outlook for potential output growth.
In our November 2016 forecast, our first following the June 2016 referendum, we revised down our potential growth forecast, primarily reflecting the effect of weaker business investment on productivity growth. To give some context to our central forecast judgements, this box outlined a number of channels through which the decision to leave the EU could affect potential output and the uncertainty associated with estimating these effects.
Post-crisis revisions to potential output and productivity in the UK and US
The path of productivity growth is a key driver of GDP growth in our forecast and is also one of the most uncertain judgements. In March 2016, given persistent weakness in outturn data, we revised down our forecast for productivity growth. But this issue was not specific to the UK, with productivity having disappointed in many other major advanced economies. This box compared different vintages of UK and US productivity and potential output forecasts since 2010 to illustrate this point.
Economic cycles and the long-term projections
In our 2015 Fiscal sustainability report, we assumed that GDP grows in line with its historical trend. This in effect implied 47 years of uninterrupted trend economic growth in our central projections. This box considered the alternative paths for debt as a share of GDP under an symmetric and asymmetric cycle, highlighting the sensitivity of the net debt projections to economic cycles.

Economy categories: Nominal GDP, Output gap

Fiscal categories: Public sector net debt, Primary balance

The cyclicality of spending on benefits and tax credits
In our 2014 Welfare trends report, Chapter 4 reviewed the overall trends in welfare spending. In this box, we considered how responsive welfare spending is to the economic cycle by estimating the elasticity of benefits and tax credits spending as a share of GDP with respect to changes in the output gap (the difference between actual GDP and an estimate of its potential or underlying level). We found that the most counter-cyclical benefits have caseloads closely associated with the economic cycle whereas mildly counter-cyclical benefits are likely to only exhibit cyclicality due to spending varying less than GDP, thereby producing a denominator effect.
In the February 2014 Inflation Report the Bank of England published more information about its assessment of spare capacity. This box compared that assessment with our own output gap estimate at the time, highlighting some conceptual differences between the two.
In early OBR forecasts we estimated a significant negative output gap following the late-2000s recession, which we did not expect to have closed by the end of the forecast horizon. Our March 2013 forecast implied that potential output would be 14.6 per cent below an extrapolation of its pre-crisis trend after five years, with actual output a further 2.3 per cent below that. This box examined the implications of that forecast, as well as the fiscal implications of some possible alternative assumptions.

Economy categories: Potential output, Output gap

Fiscal categories: Structural deficit

Our latest estimates of the output gap - which extended up to the third quarter of 2012 - implied a narrowing of the output gap since our previous forecast, despite actual output having remained broadly flat. Given the strength in the labour market over the period suggested a sharp fall in trend total factor productivity (TFP). This box set out the methodology behind that assessment, based on a production function approach that allowed us to separate out productivity growth into contributions from capital deepening and TFP.

Economy categories: Potential output, Output gap

Why might potential output growth have slowed?
Potential output growth had been relatively weak in the period following the late-2000s recession. This box discussed some possible reasons, noting that indicators available at the time did not indicate a structural deterioration in the labour market.
In our central forecast, interest rates are assumed to evolve in line with financial market expectations. For alternative economic scenarios which involve different paths for the output gap and inflation, it is useful to specify rules for the way monetary policy is set and for how output and employment will respond. In this box, we set out the rules that governed those relationships in the scenarios we analysed in the March 2011 Economic and fiscal outlook: a persistent inflation scenario and a weak euro scenario.
Following the June 2010 Budget, the Government set out further details of the planned reductions in government expenditure in its 2010 Spending Review, including additional measures to reduce welfare spending. This box discussed the possible ways in which these measures could affect the economy's trend growth rate.
Net migration is an important source of growth in the working-age population. It therefore influences the economy’s trend growth rate by affecting potential labour supply growth. In this box in our first full Economic and fiscal outlook in November 2010, we considered how changes in migrant employment and productivity could affect whole economy employment and productivity.