Policy agenda / Professor David Miles

When the Treasury want to know the implications of a decision, they call us

Words: Peter Taylor-Whiffen

Managing Britain’s economy is challenging for any politician, especially as most have no background in economics. Inevitably they need help, and much of it comes from Imperial’s Professor of Financial Economics, Professor David Miles, a member of the Office of Budget Responsibility (OBR), whose three experts provide the government with independent economic forecasts and analysis of the public finances.

“We do not tell the Chancellor what to do,” says Miles. “Government makes its own plans on taxes and spending – but it asks us for our objective assessment on the likely implications.”

For instance, the government’s current financial priority is a rolling five-year plan to reduce the nation’s debt relative to gross domestic product, so underpinning all Miles’ analysis is the probability of hitting this target.

“The UK has an unusually high level of debt to GDP,” he says. “The pandemic, the war in Ukraine and the energy crisis have left the government trying to grapple with issues beyond its control. If the debt relative to national income keeps rising, the world’s investors will become more wary of lending the UK government money, so it’s sensible to prioritise reducing it and paying less interest.”

So the government sets out plans and the OBR uses modelling to forecast the potential impacts on spending and tax revenue. “There’s a lot of data on the effect of interest rates on mortgage rates, the impact of mortgage rates on people’s disposable income, the knock-on hit to consumption and the effect of consumption on demand for firms’ output,” says Miles. “Our mathematical models, based on many decades of data, give us a guide – but no more than that – as to how things will play out.”

But other factors mean models have to be created from scratch. “Some things are not so easy to forecast. UK net immigration last year was 500,000, but you have to calculate the proportion of those that are of working age and who will find jobs, and whether their immigration is permanent or more transitory. The more who work, the more that reduces the welfare bill and raises income tax receipts, which can hugely impact fiscal debt. Then there are longer term domestic demographic factors such as fertility rates and an ageing population.”

Government makes its own plans on spending, but asks for our objective assessment

On top of that are economic shocks to factor in, such as COVID-19, whose legacies include longer NHS waiting lists. “There’s an enormous increase in people whose poor health prevents them working,” says Miles, whose research has included several meetings with UK chief medical officer Sir Chris Whitty. “Is this temporary because of COVID-19 or down to longer term health problems, such as mental health or obesity?”

Equally unexpected was a 500 per cent increase in gas prices. “Before Russia invaded Ukraine, gas prices had pretty much flatlined for ten years,” says Miles. “But we’ve recently had to work quickly on economic analysis of a shock whose scale and magnitude had seemed implausible.”

Other recent events have also proved why his team’s analysis is so vital. The fiscal chaos of Liz Truss’s brief tenure as Prime Minister came after she ignored the OBR. “We were prepared to carry out analysis to be published alongside the government’s mini-budget, but we weren’t asked,” he says. “We can’t force the government to do anything. But when Jeremy Hunt became Chancellor, we were asked for input and a full OBR report was published alongside his budget.”

But forecasting the future isn’t easy. “The biggest challenge is the slowing rate of productivity,” says Miles. “From the end of the Second World War to 2008, labour productivity – the key driver of wages – was rising at just over two per cent per year, meaning people’s standard of living rose around 50 per cent every 20 years. But since the 2008 financial crisis, productivity and wages have risen annually barely half a per cent. That means GDP is 25 to 30 per cent lower than you’d have predicted 20 years ago.

“Is this just an unlucky run of blips – the financial crisis, COVID-19, war – meaning things will return to previous levels? Or was the blip actually the whole of the 20th century, an exceptional period of increased standard of living through inventions, discoveries and developments, and should we just get used to the fact we are returning to what was normal before that?

“And that leads us to another question: what impact will today’s technological developments, such as AI or ChatGPT, have? The answer will have significant implications, and an important role of the OBR is to assess their magnitude. They will affect how we all live in the future.”

Professor David Miles is Professor of Financial Economics at Imperial College Business School and a member of the Budget Responsibility Committee of the Office for Budget Responsibility.