When governments set economic policy, they can’t just be concerned with the here and now. Some measures only take effect with a lag. Some will bring benefits, but only years – or decades – into the future; others will bring economic costs that accumulate only gradually over time. The sustainability of the nation’s finances is not determined by the borrowing numbers for this year, but by the longer-term outlook.
For these and many other reasons, the chancellor’s budget decisions have to be made based on what the future is expected to look like: a forecast. Economic forecasting is famously difficult – its only purpose is to make astrologers look respectable, as the rather tired saying goes. But it’s essential.
In the UK, economic and fiscal forecasts have been produced by the independent Office for Budget Responsibility (OBR) since 2010. That means we no longer need to worry about the Treasury fudging the forecast when it is politically advantageous to do so. Instead, we’ve got a new set of issues around how the forecasts are used. We’ve somehow ended up in a world where minor forecasting judgements by the OBR are having an outsized impact on policy decisions. This is not a good place to be.
It’s important to be clear about why we’re here. The main reason is that the government has chosen a pass-fail fiscal rule and chosen to meet it by the finest of margins under the OBR’s central forecast. Rachel Reeves, like her predecessor Jeremy Hunt, has opted to meet her rules by a margin of about £10bn. That’s about one-third of the average buffer since 2010, and is effectively a rounding error in the context of a forecast for a £3,000bn economy. Andrew Balls from Pimco recently compared this strategy to driving somewhere 50 miles away with 50 miles’ worth of petrol in the tank.
The result has been that from budget to budget, policy is seemingly being determined by what has happened to the forecast since last time around. Things have gotten a little better? Great! We can cut taxes. Things have gotten a bit worse? Uh oh! We’d better pencil in some spending cuts to get us back on the right side of the line. Things have gotten worse, but not by as much as we were expecting a week ago? Stand down! Maybe we don’t need to break that manifesto tax promise after all.
The future is uncertain. Macroeconomic forecasts are inevitably volatile. New data comes in all the time. Things change, and sometimes it’s absolutely right that policy is adjusted in response, particularly if we now expect the future to look materially different in some important way. But we surely need to get away from a world where major tax and spending decisions – and major political decisions – are made in a rush, in response to small movements in the OBR’s central estimate of where government borrowing will be in four or five years’ time. That this back-and-forth increasingly plays out in public only fuels speculation and uncertainty, which comes with real-world consequences.
What’s to be done? In the short term, the fiscal rules and the fiscal framework aren’t going anywhere. To overhaul the system at this moment would be far too risky. The UK is still on the naughty step with the investors who lend it money, where it has been since 2022. Markets want the government to show that it can follow through on plans to get its fiscal house in order – they want actions, not just words.
As a short-term step in the right direction, the chancellor might helpfully build in a bigger buffer – increase her so-called “fiscal headroom” – at this budget to reduce the risk of being back in the same position in six months or a year. The OBR, for its part, could do (even) more to stress the uncertainty around its forecast, and perhaps report “headroom” as a percentage probability instead of as a pounds billion number, to get away from the idea that it’s free money waiting to be spent.
The IMF has suggested that compliance with the rules could be assessed less frequently. Others have suggested that the second forecast should be scrapped altogether, as a rather blunt means of shutting down speculation (you can’t over-respond to a forecast change if there’s no forecast). Wonks like me can quibble about the specifics, but these options all merit consideration. Something needs to change.
Looking further ahead, if we can get our house in order (and it is an if, given that just to stabilise our debt now requires tighter fiscal policy than we have managed for a quarter-century), there’s a case for a wider rethink. We need forecasts, yes, but we don’t need to pin quite so much on them, or adjust policy one-for-one when they move around. We need some sort of fiscal framework, yes, but we don’t need to obsess about the OBR’s forecast for one particular measure of borrowing or debt to the exclusion of all else.
Once the dust has settled on this budget, I plan to write about what a credible alternative framework could look like, drawing on work we’re doing at the Institute for Fiscal Studies. In the meantime, I forecast a bumpy couple of weeks ahead.
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