A fiscal watchdog should not need a crystal ball


To: Robert Chote, Director, The Institute for Fiscal Studies

Dear Robert,

Congratulations on your appointment as chairman of Britain’s new Office for Budget Responsibility. When I directed the Institute for Fiscal Studies 25 years ago, it was difficult to persuade journalists and parliamentarians that the think-tank’s figures were as good as official data. Now the government can reassure journalists and parliamentarians of the quality of its data only by securing the imprimatur of the IFS. The difference is partly the result of your success in establishing a reputation for independence and partly the failure of government to monitor that reputation for official data.

But it concerns me that the OBR is widely described as a forecasting body. No reliable means of predicting economic growth three to five years ahead exists, or is likely to exist. It is possible that recovery will lead to rapid growth in tax revenues, and the deficit will reduce rapidly. It is also possible that a loss of business confidence aggravates the impact of public expenditure cuts and the current deficit proves intractable.

Anyone confident in predicting either outcome is a fool, which you certainly are not. There will always be a demand for forecasts, so there will always be a supply. But the reputation of economic forecasters, like other quacks and charlatans, depends more on the slickness of their presentations than the value of their work.

Such presentations are not a job for you. Nor are they what the OBR should be about. The basic issue is the need to restore confidence in what government tells us. The Labour government in 1998 announced a new, and sensible, fiscal framework. Current receipts and current expenditure should balance over a budgetary cycle, and debt should not exceed a specified percentage of national income. Finding those requirements irksome, however, that government engaged in extensive and expensive attempts to circumvent its self-imposed rules. These measures included off-balance sheet funding, conceptual redefinitions and bullying of statistical agencies. The process became one of self-congratulation rather than budgetary discipline.

Problems of this kind are not uniquely British. They have afflicted other countries as far apart as Greece and the US, and have persuaded several other countries – though not these two – to establish bodies like the OBR. Put simply, governments cannot be relied on both to set targets and to monitor compliance with these targets. The job you have, or should have, is therefore more akin to audit than to forecasting. It is true that one of the devices used in the presentation of misleading budgetary data was the regular adoption of growth assumptions at the upper end of the plausible range. But this was not the most important, or the most reprehensible, distortion of fiscal data. After all, without some optimism life would be hard to bear.

You and your colleagues should focus not on what might be inside a crystal ball, but on answering the question: “What is the level of taxation that is needed to support current and future expenditure plans on a sustainable basis?” This approach is the best means of incorporating into the public accounts factors such as the rising cost of past off-balance sheet financing, the consequences of past pension commitments and the impact of deteriorating future demography. Such an analysis would help to distinguish the structural element in the current deficit from the cyclical element attributable to the recession and countercyclical policies. The calculations required are ones that your office can undertake in a detached and objective manner.

I fear that the answer is very discouraging. That is why, although the depressed state of economic activity seems to demand further stimulus, I think the government is right to plan large cuts in public expenditure. But I – and, I expect, the coalition – would be happy if your office could prove me wrong.

Yours ever, John

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