Photo credit: www.theguardian.com
Two years ago, Rachel Reeves’ address as shadow chancellor at Labour’s annual conference included a rather specific proposal that unexpectedly resonated well with the audience. The focus was on enhancing the powers of the Office for Budget Responsibility (OBR). Following the turmoil surrounding Liz Truss’s premiership, this initiative was met with enthusiastic approval in Liverpool.
The upcoming week presents a new challenge for Reeves. As chancellor, she will deliver her spring statement to the House of Commons, likely addressing OBR forecasts that suggest her self-imposed fiscal guidelines are at risk of being violated unless corrective measures are taken. This sets the stage for potential benefit reductions and tighter spending policies from the government.
Reeves faces mounting pressures due to rising government borrowing costs, sluggish economic growth, and persistent inflation—all factors that are expected to eliminate the £9.9 billion buffer she had previously identified against her principal fiscal rule, which mandates that current day-to-day expenditures match revenue within five years.
The situation could have unfolded differently. Charlie Bean, a former deputy governor of the Bank of England, has cautioned against abrupt policy cuts. He advocates for a more pragmatic approach, suggesting that temporarily breaching the fiscal rules might be reasonable given the unpredictable nature of economic forecasts. He noted that Reeves could revisit fiscal conditions in just a few months during the spending review or the autumn budget.
Bean commented, “That said, simply stating this may not be enough given the current circumstances, particularly as Reeves’s credibility has likely diminished.”
A significant aspect of the conversation centers on Reeves’ rigid adherence to her “non-negotiable” fiscal parameters. Her reluctance to emulate the extensive tax reforms of the previous October has led to spending cuts emerging as the favored option politically. She has, notably, emphasized the importance of maintaining a strong relationship with the OBR.
However, sentiments within Labour are shifting, largely due to the OBR’s deep involvement in policy formulation. An insider remarked, “There is a pervasive sense of pessimism at the moment, with little indication of improvement on the horizon. The existing cycle, characterized by two annual forecasts and a single budget, is proving to be a logistical headache.”
Historically, breaching fiscal rules is not unprecedented. George Osborne, credited with founding the OBR in 2010, did so twice in subsequent years, showcasing the flexibility within these frameworks. The targets themselves have undergone modifications at least eight times since their inception, reflecting a lack of longevity in the government’s fiscal guidelines.
While a £10 billion surplus may seem substantial, it pales in comparison to the UK’s £2.6 trillion economy and a government expenditure exceeding £1 trillion annually. Experts predict that failing to meet these fiscal goals is increasingly probable.
Jagjit Chadha, a professor of economics at the University of Cambridge, argued for the necessity of allowing for some leeway in the rules. He analogized navigating economic challenges to changing one’s approach during adverse weather conditions, emphasizing flexibility over strict adherence.
Chadha further noted that maintaining credibility with financial markets does not require precise alignment with fiscal targets at all times, citing the Bank of England’s own struggles to consistently meet its inflation objective.
The Treasury, however, remains cautious about the implications of breaching fiscal guidelines. Concerns linger about a potential repeat of Truss’s controversial fiscal approach, especially as government borrowing costs soar amidst apprehension regarding the UK’s economic status.
Andy King, a former OBR member, expressed that the fiscal stance being taken indicates a commitment to the current stringent rules. He remarked, “There’s anxiety that adopting a more lenient approach could undermine perceived seriousness about addressing the deficit.”
Prior to the establishment of the OBR, the Treasury managed its own economic forecasts, often leading to overly optimistic scenarios. This led to the creation of the OBR as a means to impose accountability and transparency in fiscal policy-making, especially post the 2008 financial crisis attributed to previous Labour administrations.
Currently, the OBR is required to furnish two forecasts each year, including one tied to the budget. This process ensures that Treasury proposals are integrated into the OBR’s fiscal outlook, with back-and-forth exchanges enhancing the integrity of the forecasts.
In this meticulous process, the OBR operates from its distinctive location within the Ministry of Justice, producing forecasts that significantly influence the Treasury’s fiscal strategy and decisions.
As the spring statement approaches, a recurring phrase within the Treasury captures the prevailing concern: “Does it score?” This question evaluates whether proposed tax or spending measures will be positively or negatively reflected in the OBR’s forecast assessment.
Given the risk of transgressing her fiscal limits, Reeves faces substantial pressure to align her policies with this scoring criteria. Tensions have risen particularly between her and Liz Kendall, the Secretary of State for Work and Pensions.
Kendall has advocated for reinvesting savings from welfare changes into initiatives aimed at increasing employment and reducing reliance on benefits. However, the Treasury’s preference has tended towards saving those funds instead.
In assessing policies, the OBR seeks robust evidence to validate its evaluations. Paul Johnson, director of the Institute for Fiscal Studies, indicated to The Times that the OBR might lean favorably towards the Treasury’s proposed policies.
King noted that the OBR’s role in policymaking could offer unbiased and transparent evidence to support the chancellor. However, he acknowledged that the pursuit of objectivity in economics is fraught with challenges.
“When the OBR claims that certain policies meet the necessary standards, it incentivizes the Treasury to pursue more such policies,” King explained.
Richard Hughes, leading the OBR, has encountered significant criticism for his traditional views and has faced political backlash in the past. Although some Conservative members have voiced dissatisfaction with his assessments, many economists commend his work and anticipate his reappointment when his term concludes in October.
Ultimately, the pressing issues originate not solely from the OBR’s operation but from the broader economic landscape and accompanying political complexities that must be navigated.
Gerard Lyons, chief economic strategist at Netwealth, summarized the current dilemma, stating, “High debt, low growth, and increasing interest rates lead to a challenging forecast for public finances. With already elevated spending levels and high taxation, a credible strategy for fiscal management is essential.”
Source
www.theguardian.com