Misunderstandings on the left (and elsewhere) about the OBR, independence and the bond market

 

I often see pieces from those on the left criticising the OBR. Here is Louise Haigh, for example, talking about the “rigid orthodoxy of the OBR”. Such criticisms are typically based on a misunderstanding about what the OBR does, or deflect more valid criticisms of other aspects of fiscal policy onto the OBR’s shoulders where they do not belong. This is generally linked to more general criticisms of the OBR and Bank of England, suggesting that both institutions create a ‘democratic deficit’. While some independent central banks do create democratic deficits, ironically this is much less the case for the Bank of England and is certainly not the case for the OBR.

With both institutions, what the government has done is delegate to experts a task that requires a high degree of technical skill, in an area where that skill could easily be overridden by short term, party political or personal advantage. The example I generally quote, which I was told about on good authority, is a Chancellor before the Bank became independent who said that they knew interest rates had to increase, but there was no way he was going to do that until after the party conference. In this case a politician was exploiting the fact that advice was secret to enhance party or personal popularity. That is hardly democratic.

The Bank of England is tasked with meeting an inflation target set by the Chancellor, over a period that is roughly set by the Chancellor/Treasury. The interest rate required to achieve this target is largely a technical macroeconomic question, and as such does not create any significant democratic deficit. [1]

The macroeconomic consensus is overwhelming that independent central banks produce better outcomes, and I agree with that consensus. Just look at the United States right now. Trump says the economy is booming, and therefore interest rates should be lower. If he could set interest rates, they would be far lower right now, and that would probably increase inflation further above target, requiring interest rates to rise again later. From any objective point of view an independent central bank produces a better outcome than with Trump setting rates.

Now thankfully not all governments are like the current US administration. But a lot of commentary on the left implicitly assumes a government that is benevolent, by which I mean one that always takes decisions to maximise social welfare. (The politics comes in how you define social welfare.) Even if we were to assume that governments on the left were like this, the whole point of democracy is that such governments can lose power, often to administrations that are not benevolent.

Independent institutions can protect society from the consequences of non-benevolant behaviour by politicians. We have a justice system where juries decide on guilt or innocence, and judges make decisions about prison sentences, because to give politicians that power would be dangerous, yet neither juries nor judges are democratically elected. A pluralistic democracy is all about giving other institutions besides parliament or the executive a limited degree of authority to make decisions. The populist right hates this, which is why they tend to try and end this independence. It is a shame that some on the left sometimes seem to side with the populists on this. [2]

The OBR does not take any decisions. All they do is forecast. Forecasts involve an assessment of how society will behave in macroeconomic terms over the next few years. When I was a lot younger I did a good deal of macro forecasting, and at no point can I recall politics coming into it. A parallel I often draw is with assessments by NICE about the effectiveness of new drugs. Sure, politicians often prefer some forecasts to others, just as they might prefer some NICE assessments to others, but if you think about why that is, it only strengthens rather than weakens the case for keeping politicians out of the process. I don’t think I have read much talk about how NICE creates a democratic deficit in health policy.

Haigh gives some examples of why the OBR represents a case where “opaque watchdogs outrank democratic choice”: underestimating the impact of public investment, or the macro benefits of public spending like ‘Sure Start’. But independent institutions tend to be far more open about their assessments than government departments, and governments and the public alike are free to challenge those assessments. The OBR attempts to provide analysis that represents a consensus view among experts. I would much rather that than wishful thinking by politicians who generally think their policies will have a greater impact than they actually do. Calling this consensus ‘orthodoxy’ is just name calling.

It is not the case, as NEF suggest here, that the government is obliged to make fiscal decisions based on the OBR’s judgements. Legally any government could say that it is not meeting its fiscal rule in the OBR’s forecast because it believes the OBR is wrong. It could claim, for example, the OBR is underestimating the impact of public investment. That this never happens is generally because the OBR’s judgements are following the consensus, and as a result politicians are not prepared to take a public bet on their own optimism.

Some wonder why fiscal decisions should be based on forecasts at all, because judgements made in those forecasts can have a big influence on policy. But when Chris Giles says that “this is no way to conduct public finances in a mature democracy” he is completely wrong. The only alternative to basing fiscal policy on forecasts is to base it on current data, and that would make fiscal decisions far more erratic. The Bank bases interest rate setting on forecasts, and the reasons to look ahead when making fiscal decisions are stronger still.

It would be perfectly possible for the Treasury rather than the OBR to do the forecasts on which policy is based, and as NEF suggests let the OBR provide an alternative forecast that focuses on areas of disagreement. That is transforming the OBR into more of a fiscal watchdog, which is making it closer to independent fiscal institutions in some other countries. My own view is that this would make policy worse rather than better, particularly when you remember that a right wing populist government could well be in power. Macro forecasting is difficult, and rarely gets things right, but I would much rather policy was based on experts making those forecasts than politicians engaged in wishful thinking.

An example of misdirected criticism comes from the cuts in welfare spending last Spring. It wasn’t the OBR that chose to forecast twice a year, it was parliament that mandated the OBR to do so. It wasn’t the OBR that required a fiscal correction following that forecast rather than wait until the autumn, but the government. Equally the Bank’s sales of its government debt is something that the government should take a greater interest in, and the Bank should and would adjust its policy to accommodate government wishes.

What about Andy Burnham’s statement that the government should not be in hock to the bond markets? That statement doesn’t make much sense [3], but equally neither does much mainstream comment on the bond market, which talks as if this market had a veto on fiscal policy. The problem the UK government faces now is not an inability to borrow, but rather hat it is expensive to borrow. It is relatively expensive for the UK government to borrow not because of the size of the deficit or the amount of UK government debt, but because UK short term interest rates are relatively high because UK inflation is relatively high.

There is quite understandable frustration at the moment on the left and elsewhere about the continuing fiscal squeeze on many if not all parts of government spending. I share that frustration. But for once the source of the problem is pretty clear. It is not the fault of the OBR, who are just trying to forecast as best they can the likely level of tax receipts and government spending over the next few years. It is not the fault of the fiscal rule that currently binds, which requires current government spending to match taxation in a few years time. No one to my knowledge has suggested why that rule is not appropriate in the current macroeconomic conjuncture. Nor is it the fault of the bond markets.

The current problem with fiscal policy in the UK is quite simple. The government is not raising enough in tax. Most people, understandably, want a level of public services comparable to our neighbours in Western Europe. The amount of taxes we collectively pay, however, is significantly below most countries in Western Europe. This was not the case in 2010, but is a consequence of 14 years of Conservative government. As the last Labour government showed, if you want better public services than a Conservative government typically provides you need to raise taxes.

[1] The set of interest rates necessary to achieve the goals set by the Chancellor is not unique, however, and any choice may involve issues which different politicians might have different views about. That is why the Bank’s job is not completely technocratic. This problem is well understood, and is dealt with by many central banks by defining secondary objectives like employment. In the UK it is easy for the government to provide the Bank with additional direction in general terms about how it views such trade-offs.

[2] Adam Tooze asks here whether MAGA attacks on central banks might spur those on the left “to define what a democratic politics of central banking might look like”. In this post I’m kind of asking the same question, but with rather different motivations. If you are prepared to condemn independent central banks as undemocratic and technocratic, then are Trump and MAGA in this instance doing what you have always wanted?

[3] We don’t say we have a cost of living crisis because UK consumers are in hock to the goods market.