Nipping it in the Budd: Enhancing fiscal credibility?

In our blog article IMF warns of the long-term need for fiscal consolidation we highlighted the concerns that the IMF had about the size of public debt-to-GDP ratios in those countries with weak fiscal credibility. Since 1997 the UK has undertaken a series of measures designed to enhance the credibility of fiscal policy and, in particular, to dispel the notion that fiscal policy is unduly sensitive to political needs. Firstly, we have seen the introduction of a Code for Fiscal Stability which outlines a series of principles which should underpin fiscal policy measures. Secondly, in response to the worsening state of the public finances, we have seen the introduction of a Fiscal Responsibility Act which requires governments to outline plans for delivering sound public finances and places a duty on them to deliver them.

The new UK coalition government is now introducing a new independent Office for Budget Responsibility (OBR) which will have responsibility for assessing the public finances and the economy, including the generation of forecasts, and for assessing the public-sector balance sheets (i.e. the sector’s assets and liabilities). The OBR will begin its work immediately in readiness for an ‘emergency Budget’ on the 22nd June. According to the HM Treasury press release on 17 May the OBR will be headed by Sir Alan Budd, an economist who was a founder member of the Monetary Policy Committee (MPC) of the Bank of England. Sir Alan will head a 3-member Budget Responsibility Committee (BRC) which will be supported by economists and public finance experts currently working in HM Treasury, but who in the longer-term will redeployed from the Treasury. Legislation will be drawn up in order to establish the OBR on a permanent statutory basis.

In arguing the case for the OBR, the government points out that all Budget forecasts since 2000 of public borrowing for more than ‘1 year ahead’ have underestimated borrowing. For instance, the average error for ‘2 year ahead’ forecasts since 2000 is £29.5 billion, i.e. borrowing for the financial year after next has, on average, turned out to be £29.5 billion higher than predicted. Of course, we would expect shorter-term forecasts to be more accurate. The evidence presented shows the average error for ‘1 year ahead’ forecasts since 2000 to be £6 billion, i.e. actual borrowing in the following financial year has, on average, been £6 billion higher than forecast. But, more than this, since 2000 four Budgets – those in 2000, 2006, 2007 and 2009 – have produced ‘1 year ahead’ forecasts that over-predicted levels of borrowing.

While it will certainly be fascinating in the years ahead to assess the accuracy of the OBR’s own crystal ball in forecasting, the creation of the OBR is undoubtedly an interesting development in the way in which fiscal policy is both designed and implemented in the UK.

HM Treasury Press Notice
Chancellor announces policies to enhance fiscal credibility HM Treasury (17/5/10)

Articles

Osborne braced for cuts Financial Times, Lionel Barber, George Parker and Chris Giles (17/5/10)
Chancellor launches audit of government spending Independent, Andrew Woodcock (17/5/10)
Osborne gives up power to forecast Financial Times, Chris Giles (17/5/10)
Why the Office for Budget Responsibility Matters BBC News blogs: Stephanomics, Stephanie Flanders (17/5/10)
Osborne confirms new U.K. budget watch dog MarketWatch, William L Watts (17/5/10)
Osborne warns of ‘disastrous consequences’ for economy BBC News, Ben Wright (17/5/10)
Chancellor announces new fiscal watchdog BBC News (17/5/10)
Robert Chote on new OBR BBC Daily Politics, Robert Chote (17/5/10)
George Osborne discovers the joys of kitchen-sinking Telegraph, Tracey Corrigan (17/5/10)
George Osborne tackles Labour’s toxic handover Guardian,
Larry Elliott (17/5/10)
Mixed reaction to Office for Budget Responsibility Public Finance, Jaimie Kaffash (17/5/10)

Questions