Britain’s budgetary watchdog is now more indispensable than ever

As parliament awaited the Queen’s Speech on Thursday, a more modest event got under way nearby in Westminster. The Office for Budget Responsibility (OBR) presented two reports, one on its forecasting record since 2016, the other on recent welfare trends. With pomp and ceremony on display elsewhere, the presentation attracted little attention but the fiscal watchdog will be centre-stage early next year, when Chancellor Sajid Javid presents his first budget. The OBR’s job will be to spell out in sober forecasts what Boris Johnson’s rhetoric and Javid’s decisions really mean for the public finances.

The OBR’s prominence demonstrates the importance of institutional reforms. Freeing the Bank of England to set monetary policy in order to meet the government’s inflation target was a masterstroke of Gordon Brown when he became chancellor in 1997. Having an independent central bank made it easier to adopt unorthodox measures such as quantitative easing to support the economy after the financial crisis of 2008 and helped steady the ship during the economic and financial turbulence that followed the Brexit vote in 2016. Today’s announcement that Andrew Bailey, currently head of the Financial Conduct Authority, will replace Mark Carney as governor when he steps down in mid-March puts another safe pair of hands at the Bank’s helm.

The OBR is a more recent innovation, but it has already proved the value of an independent public institution in the fiscal realm since 2010, when George Osborne established it on becoming chancellor. Budgetary policy rightly remains the preserve of the Treasury but the OBR is charged with examining and reporting on the sustainability of the public finances. It conducts the economic and fiscal forecasts that frame the chancellor’s decisions. And it assesses how the public finances are performing with respect to the Treasury’s fiscal targets.

One virtue of stripping forecasting away from the Treasury is that the OBR can be open about its record in a way that departments answering to ministers cannot be. Indeed, the act setting up the watchdog obliges it to evaluate its forecasts. On Thursday the OBR revealed how the ones it made in 2016, ahead of the referendum vote in June and after it, compared with actual outcomes since then. The spring forecast, which assumed that Britain would stay in the EU, proved to be too upbeat for the economy but was broadly right fiscally. The autumn forecast, which took account of the Brexit vote, was pretty accurate economically but too gloomy fiscally.

One reason to conduct such analysis is that the OBR itself can learn from it. Among the lessons it identified in the report is that it is tricky to anticipate how quickly shocks, such as the Brexit vote, take their toll. An even more compelling reason is that the exercise promotes transparency and accountability. By being open about its record, the OBR can demonstrate that it is dispassionate in its methods as well as showing the inherent uncertainties of forecasting.

At the start of the week the OBR had issued the revised version of its last forecast, in March, which it had to drop at short notice in early November on the dubious grounds that it was inconsistent with official guidance about publications during an election. This was not a new forecast, factoring in subsequent macroeconomic and fiscal developments and including new policy decisions. Instead the OBR “restated” the March figures to incorporate a variety of statistical changes to the public finances that have occurred since then.

The new version (unchanged from what the OBR had planned to publish on 7^th November) showed that the scope for additional borrowing in 2020-21, while still meeting the Treasury’s target to run a deficit that year below 2 per cent of GDP, is much more limited than appeared to be the case in March. Then, the OBR estimated that the government could borrow an extra £26.6bn in 2020-21 though it pointed out that a new accounting treatment of student loans would reduce this margin to around £15bn when it took effect this autumn. But the updated forecast shows that the fabled “headroom” has shrunk further, to a mere £7.5bn, mainly because of the discovery of a hefty double-counting error by HMRC. The tax authority had been overstating corporation tax revenues, causing projected receipts in turn to be too high (by £4.3bn in 2020-21).

What this means is that Javid’s rushed-out spending announcements in early September will break the fiscal rule that the chancellor inherited from Philip Hammond, since they will push up planned spending on the public services in 2020-21 by £13.4bn. In practice, this will not matter since Javid pledged on 7^th November to introduce a new set of fiscal rules. The first of these will be to run a balanced current budget, meaning that revenues cover day-to-day spending (but not net investment), within three years.

Based on the original March figures that rule appeared to provide ample room for manoeuvre, since for example they envisaged a surplus of £29.3bn in 2020-21. However, that margin has since been slashed, to £13.3bn according to the restated forecast. That is only just above the £11.7bn increase in current spending that Javid announced on 4^th September (the overall £13.4bn includes £1.7bn of additional capital outlays). Taking into account the costings in the Conservative manifesto which estimated a net expense of £1.4bn of various spending and tax commitments, it is touch and go whether the government will balance the current budget in 2020-21. Although the new fiscal rule will not bind next year, the tight squeeze illustrates the potential problems that lie ahead.

In practice what will matter much more is the OBR’s overall take on the economic and fiscal outlook when it prepares its fully fledged forecast for the budget. (A thorny difficulty is that it is supposed to make two forecasts each financial year, which now looks virtually impossible.) That role in the fiscal process was created by a government intent on reducing a big deficit. The OBR spoke truth to Osborne and Hammond during the era of austerity. Now it faces a government keen to spend more but less keen to raise taxes in order to finance higher expenditure. The OBR is needed more than ever to maintain fiscal honesty by a government that will be inclined to throw its weight around after Johnson’s big election victory.