The OBR has opened a can of worms

The Office for Budget Responsibility has opened up a can of worms. As we pointed out shortly after the Chancellor sat down following his autumn statement on Wednesday, the independent body has controversially moved the goalposts a big step closer to George Osborne’s ball. By ditching its models for working out how much of the deficit is permanent – and hence requires tax rises or spending cuts to eliminate – the watchdog made it much easier for the Chancellor to hit his target of eliminating the structural deficit within five years.

Buried away in the back of the OBR’s excellent report, though, is a fascinating assessment of just how far those goalposts moved. The report says:

“Roughly speaking, the output gap would have had to be about 1¼ per cent of potential output narrower than our central estimate […] to make it more likely than not that the mandate would be missed”

And then comes the killer line:

“[This] is roughly the size of the adjustment we have made between our March forecast and this one.”

In other words, even with the extra year of austerity the Chancellor announced, he would have likely missed his fiscal mandate had the OBR not junked its models and adopted a more, how shall we say, sympathetic one.

Now as it happens, that’s probably a sensible judgement. But the point here is that everything about the scale of necessary future cuts and tax rises hangs on this judgement about an obscure economic concept. And that’s a judgement that just changed radically and without warning. If the last OBR models were so wrong, who’s to say that the new production function one isn’t also wrong?

Let’s look at the effect of that on the public finances. If we take a forecaster whose estimate of the output gap is higher, such as NIESR’s implied output gap of -4.3% (NIESR give a range of -4% to -4.5%), the OBR’s analysis suggests that this would put the current budget into a structural surplus of around £40bn in the target year 2017-18. In other words, on this analysis the Chancellor is making cuts way in excess of what’s needed to balance the books.

And NIESR is hardly an outlier here. Oxford Economics estimates the output gap at -5.2% while Capital Economics recently argued that it could be -6%. Think of all the unnecessary austerity if these people are right. By junking its models, the OBR has invited a very lively debate.


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