Forecasts clouded by politics

Date: 23/05/1996

By Tim Jones

“ALL forecasts need to be interpreted cautiously.”

No, not a government health warning but the words with which Economics Commissioner Yves-Thibault de Silguy opened his presentation last week of the most politically charged set of macro-economic forecasts for years.

For reasons best known to the press, the economic predictions of the European Commission seem to carry more weight with the media than those emanating from the Organisation for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF) or the myriad of private-sector institutes that litter every member state.

As they waited for de Silguy, hoards of journalists surrounded a table in the press room of the Breydel building ready to pounce on the pieces of paper that would reveal his officials' predictions for the European Union's growth rate this year.

Yet the Commission has a poor reputation as an economic forecaster among those who really matter - the players in the financial markets who will have a decisive role in determining whether the single currency goes ahead on schedule - and its credibility suffered a further blow last week.

Getting growth forecasts wrong is one thing - everybody does that. But being the only institution to expect both Germany and France to get their respective budget deficits down to 2.9&percent; and 3.0&percent; of gross domestic product by the end of 1997 makes the Commission's predictions highly suspect.

While some (but very few) bodies share de Silguy's optimism about the German deficit, nobody - except perhaps French Prime Minister Alain Juppé and his finance minister - is forecasting a 3&percent; deficit for France by 1997. Uncannily enough, the Commission's prediction would ensure that France - with its low inflation and Exchange Rate Mechanism membership - would be perfectly on target to qualify for entry into a monetary union in January 1999.

With a deficit of 4.2&percent; of GDP expected for 1996, this would require a combination of strong economic growth and, possibly, another round of budget-cutting worth 1.2&percent; of GDP on top of the 9 billion ecu announced by Finance Minister Jean Arthuis only last week.

“I can understand exactly why they have these numbers,” says Bruce Kasman of investment bank JP Morgan. “But it is a very unlikely scenario.”

Admittedly, the French budget deficit in 1995 was virtually on target at 50 billion ecu, but this was helped by a series of one-off factors: 1.2 billion ecu of postponed spending cuts, over 2 billion ecu reclaimed from the social housing agency and an extension of the tax year into January 1996 because of the December strikes.

This year and next will be different and, as a result, the chances of France overshooting its targets are high. But de Silguy remains unfazed. “I know the commitments the French government has made and we went over them line-by-line,” he told the press conference he held to unveil his forecasts. “The signatures of a prime minister and a finance minister still mean something.”

That may be but they, as much as anyone, are dancing in the dark. Under laboratory conditions, a scientist knows that mixing together a collection of chemicals will produce an inevitable outcome.

Not so the forecaster. Forecasting the level of budget deficits in comparison with national income is like trying to climb on to a moving train. First, the economist must be able to judge what will happen to GDP (the total flow of goods and services produced in a given year), then match this with the income from taxes and spending by central and local government, as well as some semi-public institutions, which are affected in turn by the speed of growth of the economy.

“It's a very imprecise science,” says Jeremy Weltman at Consensus Economics, a company which surveys forecasts throughout the EU and averages them. “Doing it our way reduces the risk of relying too much on a particular forecaster. They can be wrong.”

In the days when the British government was a slavish follower of targeting money supply growth, one London private-sector economist was well known for his wish to be contacted last during surveys so that he could doctor his forecast accordingly to bring it into line with everyone else.

It is no wonder that policy-makers have become as cynical about the prowess of their economic forecasters as the general public is about weather men.

“I've seen a lot of forecasts in my time and they've been revised upwards and downwards,” said German Chancellor Helmut Kohl last week. “I don't play that game anymore; I calmly await the outcome.”

Dennis Healey, the UK finance minister who had to turn to the IMF in 1976 for a huge stand-by loan to bail his government out of a crisis in market confidence, learnt an even harder lesson about the dangers of imprecision.

Treasury estimates about the size of the budget deficit which forced him to go through such an humiliation, and arguably led to the downfall of the Labour government in 1979, turned out to be completely wrong.

But some forecasters are certainly more trusted than others.

“The Commission's forecasting record has been terrible,” said a specialist European economist who did not wish to be identified. “Do I think they are completely neutral and believable? No and no.”

A senior and highly-experienced finance ministry official from a member state was even more scathing. “This is why the OECD and the IMF are so important. They stand outside the EU institutions and give us reliable forecasts that nobody can influence. Nobody in the member states trusts the figures from the Commission.”

In its forecasts for the European economy published in April, the IMF was more bullish in its predictions for growth than the Commission, expecting a rise in GDP in the EU of 1.8&percent; in 1996, reaching 2.7&percent; in 1997, compared with the Commission expectation of 1.5&percent; and 2.4&percent; respectively.

But the IMF's deficit forecasts were much gloomier than those unveiled by de Silguy last week. It expects the German budget deficit to rise to 3.9&percent; in 1996 from 3.5&percent; last year, before falling to 3.4&percent; in 1997, while the French deficit will still be languishing at 3.6&percent; in 1997.

Admittedly, the German government's ambitious plan to make spending cuts worth 26 billion ecu, and the latest French plans - announced just a day before de Silguy published his forecasts but discussed with the Commission beforehand - were not factored into the IMF forecasts.

It will be fascinating to see whether they creep into the OECD's budget deficit predictions when they are published on 20 June.

Nevertheless, the Commission did not accept either the German or the French plans wholesale. Nobody expects Kohl to be able to get his entire spending-cuts package through the German parliament, especially those parts of it which have to go through the upper house, while the French are unlikely to succeed in achieving the reductions in social security spending they anticipate.

Does this mean that if both governments do manage to push their budgetary plans through in full, they will take their deficits well below 3&percent;, as the Commission predicted?

For many, the forecasts are simply too ambitious - and politically motivated. “I just cannot see how they have done it,” says Alison Cottrell, economist at investment bank PaineWebber International.

Cottrell says that if the Commission was expecting inflation to accelerate during 1996 and 1997, and tax revenues to come more from consumer spending and less from the corporate sector, then she could just about accept the forecasters' optimism on the deficits. But it is not.

The Commission has done itself few favours with these forecasts. It should come forward and clearly explain its methodology, which just might dispel the widespread belief that its predictions owe more to political imperative then economic reality. Otherwise, it will have no option but to accept that its forecasts will be taken with more than a pinch of salt.