Chris Giles UK deficit: Sir Alan’s task for Monday

George Osborne won immediate plaudits for the early establishment of the Office for Budget Responsibility to take the politics out of government economic forecasts. The hyperbole that surrounded the announcement was overdone, but the new OBR should increase trust in government forecasts and underpin UK sovereign debt markets if its performance in practice meets its promise. Monday marks its first test.

Sir Alan Budd, OBR chairman, needs to move from the easy task of reveling in the OBR’s establishment to the more difficult task of building long-term credibility for the new body and demonstrating it has not been captured by the Treasury in its short life.

Note that Monday’s announcement is a new economic and public finance forecast, based on unchanged policies. It will not include the OBR’s assessment of whether the government’s tax and spending plans give ministers a 50:50 chance of meeting their own ambitions for the public finances.

If the Office meets or exceeds the following basic requirements on Monday, it will have got off to a good start.

  • Clarity on forecast changes
    The OBR must make it absolutely clear why forecasts for the economy and growth are different from those in the March 2010 Budget. This means deconstructing forecast differences into changes in assumptions and new information received. Any merging of the two would be a disaster for transparency. The forecasting changes for growth must flow clearly into forecasting changes in tax revenues and public spending on items linked to the health of the economy such as social security.
  • Publish its assumptions on the link between growth and the public finances
    The Treasury has been keen to speak privately over the past year or two about how it decoupled its growth forecasts from its public finance forecasts. Sensible though this was as ammunition for the Treasury in the fight between Gordon Brown and Alistair Darling, it was no way to run a government or a forecast. The OBR can therefore link the two back together and explain how it believes tax revenues and public spending levels are affected by economic growth and inflation. It would be a huge cop-out for the OBR, for example, to leave the existing Total Managed Expenditure figures unchanged for different economic scenarios for the economy, since that would imply a change in spending policies.
  • Sensibly acknowledge uncertainty in forecasts
    Sir Alan has already said that he would explicitly include the inherent uncertainty that exists in his approach to forecasting. This is welcome. But with uncertainty can also come obfuscation and an inability to say anything of use, as is the case with the full range of the Bank of England’s fan chart of possibilities. How the OBR negotiates this thorny trade-off will be an important part of Monday’s announcement. It is one area, given Sir Alan’s long expertise, on which I hope and expect the OBR to show real progress. Of course, when it comes to the public finances, I expect the uncertainty to show up both on the tax and the spending forecasts. Uncertainty over economic prospects affects both.
  • Publish its assessment of already planned fiscal tightening
    The Treasury has been very vague about how much it was tightening fiscal policy in 2010-11 and beyond. Ministers wanted to conceal the effects of tax rises and the start of the spending squeeze. The OBR can rectify this by laying out clearly how much fiscal tightening was implied by the existing spending plans and tax plans in the years ahead. This is a pre-requisite for understanding fiscal policy, but requires some tricky assessments over what is a “normal” increase of public spending.
  • Reveal its assumptions on the effect of fiscal tightening on growth
    As I have pointed out, the OBR will publish a forecast based on unchanged policies and then a new one on Budget day, after the chancellor has decided how much further to cut public spending and raise taxes. This means the OBR must be clear about “second round effects” – to what extent it believes fiscal tightening hurts the outlook for growth. Its assumption here will speak volumes about its independence. But when I last blogged on the matter, I got it wrong when I said this was an issue for Budget day. The issue arises on Monday. Since fiscal tightening is already planned, the OBR needs to be crystal clear on Monday about its assumptions on the “headwinds” that stem from the existing plans for fiscal tightening. It must reveal explicitly its assumptions for the Keynesian multiplier.
  • Allow Britain to recover from “structural deficits disease”
    Much of British economic commentary lives in cloud-cuckoo land because it pays serious attention to published numbers for the structural budget deficit, when these relate to entirely notional concepts. At a very minimum, the OBR should highlight the uncertainty surrounding any estimate of the gap between actual economic output and the economy’s potential. Better would be to advise that while the concept of an output gap or a structural budget deficit is a good way to organise thoughts, it ceases to be helpful when it is written down in numbers.

    Here is why. In a forward-looking fiscal framework, it is not credible to forecast the economy temporarily running below a normal level of output five years hence. That sort of output gap would not be temporary but permanent. Since the Treasury’s forecasts run that far ahead, there is no need for artificial estimates of structural deficits or output gaps because you can be sure that the government cannot forecast above-trend growth in perpetuity. So, all you need is a growth forecast (which can be above trend for a few years after a recession), a deficit forecast and a medium-term fiscal target. This combination is sufficient to determine whether the public finances are on track to meet the fiscal framework. And over time, changes in the forecast will alter that judgment. If the OBR strikes a blow to the spurious accuracy of structural deficit calculations from British economic discourse, it will have done the country a huge favour.