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Sunday 1 January 2012

2011: The year the OBR came of age

2010 was a disastrous year: the year when global fiscal policy moved from (mild) stimulus to austerity. 2011 was the year of the Euro crisis. But I wanted to be a bit more positive, and original, so let’s highlight 2011 as being the year when the UK’s Office for Budget Responsibility (OBR) came of age. This is mainly of UK interest, but I think it says something more generally about how macro fiscal policy can be improved.
                The OBR is the UK’s fiscal council. Fiscal councils are independent fiscal institutions set up by governments to act as a watchdog over aggregate fiscal policy. They differ in shape and size around the world, but they are becoming increasingly popular. (See this webpage  or Calmfors and Wren-Lewis (2011) ‘What do fiscal councils do?’ Economic Policy.) The OBR is fairly limited in its scope, but what it does is important – it provides the forecast on which budget decisions are based.
                I first argued for a UK fiscal council many years ago, and have actively campaigned for one over the last few years. The OBR is not ideal from my point of view – in particular I think it is daft that it is not allowed to use its considerable expertise to look at alternative policies. However it is still a very important innovation that should certainly improve the fiscal policy debate in the UK, and might even at some stage improve policy.
                But why say this now, when the ‘interim’ OBR was first established in 2010 by the incoming coalition government? Well I think you can argue that November 2011 saw the first occasion when the OBR made the government do something that it did not like doing, and that might not have been done if the OBR had not been there. What the OBR did was revise down its estimate for the size of the UK’s output gap. As the output gap is the difference between actual output and the level output could be without any domestic inflationary pressure, then that is equivalent to saying that it revised down its estimate of what output will be once we have recovered from the recession. Less output means less taxes, so it also means the government can afford less spending. So the OBR said that if the Chancellor stuck to his current plans, he would have less than a 50% chance of meeting his fiscal rules.
As a result, the Chancellor announced budget plans that implied an additional squeeze on spending, which is now extended to beyond the next general election. Now I have mixed feelings about this, because I think fiscal policy in the UK at the moment is way too deflationary. I also do not know if the OBR’s analysis on the output gap is correct, although I do know it is evidence based. (I find the disappearance of so much potential output so quickly something of a puzzle.) But it remains the case that the OBR made the Chancellor do something that he would not have wanted to do.
The real counterfactual is whether the same thing would have happened without the OBR. Treasury officials will have looked at the same evidence, and might have come to the same conclusions. But then the Chancellor might have asked ‘how sure are you that the output gap is not as big as you thought last year’, and the officials would have correctly replied ‘well it is all very uncertain’. In those circumstances it is all too easy for them collectively to conclude ‘let stick with the old numbers until things become clearer’. This is not meant to be a comment on individuals: this is just how government works. A key argument behind the conservative party’s proposals for the OBR is that it prevented politicians influencing the forecast, and that is exactly what it may have done on this occasion.
So 2011 was the year in which the OBR began to make a real difference. Now bias in forecasting is not the only thing that can go wrong with aggregate fiscal policy. Once it is has been going for a few years, I would like to see the OBR’s remit extended so that it can look at the implications of alternative policies. It would also be an obvious body to filter academic research on trying to improve fiscal rules. Until it does these things, it cannot hope to improve the policy goals that governments set themselves. In short, it has a long way to go before it can convince a government not to embark on misguided austerity. But this year the OBR made a start on making fiscal policy respond to evidence rather than political convenience.

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