The economy forecast

Real GDP growth

This Forecast in-depth page has been updated with information available at the time of the March 2021 Economic and fiscal outlook.

GDP stands for ‘gross domestic product’. It can be measured in cash terms (‘nominal GDP’) or in inflation-adjusted or real terms (‘real GDP’). This section focuses on real GDP, which is a measure of the volume of goods and services produced in the economy. We split the discussion into sections that cover our:

  • Near-term GDP forecast, and
  • Medium-term GDP forecast.

To forecast real GDP growth, we use a range of approaches:

  • Over the near term, our forecast is informed by high-frequency survey indicators. In normal times, we use these to determine the degree of ‘momentum’ in the economy.
  • Beyond the near term, it would normally be informed by our estimate of the output gap and the rate at which that output gap is expected to close. This ‘top-down’ approach is also informed and supplemented by the outlook for the individual expenditure components of GDP.
  • If the output gap is expected to close within the forecast period, we would generally assume that GDP grows in line with potential output over the remainder of the forecast.

  Near-term GDP forecast

In the very short term, we generate a forecast for real GDP using high-frequency data and survey indicators. It usually covers the quarter that is currently in progress (and will therefore not be covered by outturn data) and the next quarter. These high-frequency indicators would normally allow us to make an assessment of how much ‘momentum’ there is in the economy and, therefore, whether we expect quarterly GDP growth to pick up, slow or stabilise Since the onset of the pandemic they have instead helped us assess the extent to which voluntary social distancing and official restrictions are depressing the level of activity and, therefore, the likely increase in activity once restrictions are eased and voluntary social distancing declines.

The Office for National Statistics produces monthly estimates of GDP based on output components (e.g. construction or business services). These provide the most reliable early indicators of quarterly GDP and so are used as the basis for the preliminary estimates of quarterly GDP.

To form our judgements about the likely near-term path of GDP, we also use models that incorporate other timely indicators. These might include business surveys such as the IHS Markit/CIPS Purchasing Managers’ Index (PMIs) and from the Confederation of British Industry (CBI) and Office for National Statistics. If there are specific events that we believe are likely to have affected GDP in a given quarter, we will make any adjustments that we deem necessary. This could be due to unusual weather conditions or specific events – such as the 2012 Olympic Games or the additional bank holiday for the Queen’s Diamond Jubilee. In the March 2021 EFO forecast, we made extensive use of high-frequency data to estimate the impact that the lockdown measures, and subsequent easing of restrictions, had on activity in the first and second quarters of 2021.

Our assessment of momentum in the current quarter would normally inform our judgement about GDP growth in the following quarter. This is supplemented by survey data on business expectations which, in general, are less reliable for forecasting than high-frequency, backward-looking indicators but are, nonetheless, useful.

In our March 2021 EFO forecast, our assessment of the extent to which official restrictions and voluntary social distancing were depressing activity in the first quarter, informed our judgement about the extent to which activity would recover in the second quarter as restrictions were lifted and voluntary distancing decreased. We then cross-checked our short-term output growth assumptions by considering the implications of the course of the pandemic, level of public health restrictions and other factors for individual sectors up to June 2021 when only a residual level of public health restrictions remained.

OBR staff run the various models described above and present the results to the BRC. It is ultimately the BRC’s judgement on the most likely path for near-term GDP that is published as our forecast. The BRC decide which data or models they judge to be providing the most reliable indicators at any time, or the extent to which model predictions should be adjusted to reflect one-off factors.

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  Medium-term GDP forecast

In the medium term, our real GDP forecast is typically the result of other judgements about potential output and the output gap profile, which are ultimately made by the BRC:

  • We would normally start with our assessment of the current output gap – the amount of spare capacity in the economy or the extent to which it is overheating. That assessment is discussed further in the output gap section.
  • We then decide how quickly we expect economic output to return to our assessment of its potential level. This is informed by the outlook for the individual expenditure components of GDP, as well as the conditioning assumptions upon which our economic forecast is based.
  • Once the output gap is closed, we tend to assume that GDP grows in line with the economy’s underlying growth potential over the rest of the forecast.

 

Our forecast for potential growth – the most important element of our forecast – is determined by forecasts for its components: population, participation, employment, average hours and productivity. The expected path of productivity growth is particularly important in determining the rate of GDP growth in the medium term.

We make adjustments to our GDP forecast to reflect changes in government policy that we consider to be large enough to have a material impact. One important source of adjustment happens when the Government chooses to loosen or tighten fiscal policy (by spending more/less or cutting/raising taxes). To calculate the size of these adjustments, we use fiscal multipliers that are based on external estimates in the academic literature. More detail on our approach to determining the impact that fiscal policy will have on GDP growth is available in Box 2.2 of our December 2019 Forecast evaluation report and Box 2.1 of our November 2020 EFO.

At the start of the pandemic, both demand and supply fell significantly, before recovering at different rates, with further divergences in different sectors of the economy. This meant that the output gap became a less useful concept than it would normally have been: even though output was clearly below its long-run sustainable level, that provided relatively little information about the scope for cyclical growth in the near term, as the fall in output was driven in large part by a deliberate choice to restrict economic activity in order to contain the pandemic. As a result, the medium-term path for GDP in our March 2021 EFO was also informed by the easing of public health restrictions set out in the Government’s roadmap.

Once we have a forecast for GDP growth we can then make judgements about prices and about the composition of total income and spending in the economy. It is these details – e.g. the split of national income between wages and profits, or of wages into employment and average earnings – that we use to produce our public finances forecasts.

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Boxes

Within each of our key publications we include topical ‘boxes’. These self-contained analyses are unique to this publication and tend to cover recent developments in the economy or public finances that complement the main discussion of our analyses.