Chris Giles The OBR’s flaws (and benefits)

The hyperbole over the new Office for Budget Responsibility is overdone. It is welcome because it removes some of the temptation for chancellors to massage the forecasts. It should add something to confidence in UK sovereign debt markets. And it should help restore some trust in government. But I will spend a little longer on criticisms, since  the welcome aspects were covered in depth today in the FT’s interview with George Osborne, the chancellor.

The Financial Times reported this morning that the new Con-Lib government has established the Office for Budget Responsibility in order, as Mr Osborne put it, to “change the way Budgets are made forever, [and] … restore confidence in the numbers that underpin the budget”. Er.. not quite.

  • The OBR does not stop politicians misrepresenting fiscal policy. I am not often shocked by the words coming out of politicians mouths, but I was genuinely surprised and disappointed by both Mr Osborne and David Laws, chief secretary to the Treasury,  on the morning they were announcing what is billed as a revolution in transparent government. They both announced £6bn or so of public spending cuts for this financial year. It was OK, both said, because this represented just £1 in £100 of public spending. The Treasury pair could hardly have been more disingenuous. The cuts will not come from the total public spending, but the more limited departmental spending totals excluding health overseas aid and defence. The Conservatives’ own briefing note from 8 April said:”This [£6bn] corresponds to a 2.8 per cent real terms reduction in non-protected departmental spending compared to Labour’s plans.”For completeness, because Labour was also planning to cut these departments in 2010-11 by 2.4 per cent, the Institute for Fiscal Studies estimated an additional £6bn of cuts represents a 5.1 per cent reduction in spending in the affected departments compared with last year.
  • The Treasury’s choice of time periods of comparison today are absurd. Back in March, I recommended a must-read document from the first months of Labour’s rule in 1997 and predicted the Conservatives would produce an almost identical document with almost identical hedgehog charts. Now, I do not rate myself as a forecaster, but the main difference between the 1997 and 2010 charts is colour. This is now:

    And this was then:

    In the interim period between these two charts, broadly 1995 to 2001, the Treasury was too pessimistic about its forecasts.

  • The OBR would have got the forecast hideously wrong in the crisis. Let’s face facts. The International Monetary Fund, the Bank of England, the Organisation for Economic Cooperation and Development, the Institute for Fiscal Studies and the consensus of economic forecasters all completely failed to spot the looming fiscal crisis. The OBR would have too. So it is not the solution to today’s problems.
  • The ability of a chancellor to massage the figures is limited. To hear George Osborne, it sounds as if Labour chancellors had complete freedom to give absurd economic forecasts. There must have been completely useless opposition politicians, media and independent experts unable to hold these rogues in check. As Mr Osborne knows, he and the rest of us were significant constraints on Gordon Brown and Alistair Darling. When their forecasts appeared to be a work of fiction, everyone said so and their reputation was damaged. This reputational constraint is stronger now with the OBR, but it is simply false to suggest it did not exist in the past.
  • The use of the “structural budget” as a fiscal target leaves lots of room for games. I am really disappointed that Mr Osborne is determined to set his fiscal goal as elimination of the current structural deficit. It is hard enough for the OBR to forecast the budget deficit. That is the difference between two very large numbers, so making small mistakes on tax revenue or spending forecasts translates into big forecast errors in the budget deficit forecast.It is completely impossible to  forecast the structural budget deficit which is the relatively small difference between two large notional numbers. Uncertainties are so large any forecast of the structural deficit falls into the “made up” category.  I do not see the particular advantage in having independent people making up forecasts rather than Treasury officials.Use of structural deficits as a target also fails to learn lessons from capital rules in the banking crisis. Basel II capital ratios were complicated and based on risk-weighted assets, also notional numbers. The Basel III proposals seek to augment risk-weighted assets with a simple leverage ratio to stop gaming of the system. At least you can measure leverage is the theory.Well you cannot measure the structural deficit and unless the fiscal target is augmented with a simple deficit rule, then I fear the new fiscal framework will fail to live up to its billing as a big step forward.
  • Huge power still rests with the chancellor. And I feel sorry in advance for the OBR – fine people that they genuinely are – because they will, at some future point, be forced into an argument against a chancellor on the basis of a difference in the structural/cyclical split of a borrowing forecast. This is an impossible position for unelected officials. There will never be an argument that the OBR can present that will prove its assessment of the cycle is superior to the chancellor’s or the Treasury’s. So, the OBR is likely to concur with the chancellor on the structural deficit. Paradoxically, that puts the chancellor back in charge of the forecast that matters for his fiscal rules.
What is really needed for fiscal sustainability is announcements of tax increases and spending cuts. These are promised. So Mr Osborne and Mr Laws still have the scope to devise a workable fiscal consolidation for Britain. The OBR is not it.