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
  • 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, which we use to determine the current degree of ‘momentum’ in the economy;
  • beyond the near term, it is 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; and
  • if the output gap is expected to close within the forecast period, we would generally assume that GDP grows broadly 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 growth from which we infer whether the output gap will narrow or widen. We use high-frequency data and survey indicators to produce that forecast. It usually covers the quarter that is currently in progress (and will therefore not be covered by outturn data) and the next quarter ahead. So in a March Budget, it would cover the first and second quarters of the year. These high-frequency indicators 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 remain steady.

    The Office for National Statistics produces monthly data on the output components of GDP (e.g. construction or business services), which together represent a high proportion of total GDP. These provide the most reliable early indicator of overall GDP growth and these data are used as the basis for the preliminary estimates of quarterly GDP.

    In forming our judgements about the likely near-term path of GDP, we also use models that incorporate other timely indicators. These include business surveys such as the CIPS/Markit Purchasing Managers’ Index (PMIs) and surveys from the Confederation of British Industry (CBI). 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.

    Our assessment of momentum in the current quarter informs 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 the high-frequency backward-looking indicators, but are nonetheless useful.

    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 (in particular, about potential output and the output gap profile), which the BRC then consider and decide whether to make further adjustments:

    • we 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 (coming soon);
    • 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; and
    • once the output gap is closed, we tend to assume that GDP grows broadly 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: employment, population, 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 further adjustments to our forecast to reflect changes in Government policy that we consider to be large enough to affect the path of GDP growth materially. 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. More detail on the size and application of these multipliers is available in Box 3.2 of the July 2015 EFO.

    In our March 2017 forecast, we estimated that output had moved slightly above trend at the end of 2016. Our forecast for a shallow growth slowdown over the coming year means we expect a small margin of unused capacity to open up by the end of 2017. With output close to its potential level throughout the forecast, the modest strengthening of GDP growth from 2018 onwards is consistent with our assumption that potential productivity growth will pick up towards its historic average in the coming years.

    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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