The big news out of George Osborne’s Autumn Statement last week was the abandonment of his fiscal rules. But the real story for economists was in the OBR’s forecasts. There were two rules:
- The cyclically adjusted budget deficit must be eliminated within five years (a rolling window); and,
- Debt must be falling as a percentage of nominal GDP by 2015-16.
What’s notable about both of these rules is that they are about a future balance, so whether they have been met is presently a matter of judgement for the official forecaster. That forecaster is the Office of Budget Responsibility, an independent body that is incredibly transparent about its models, methods, and judgment. In this Autumn Statement its forecasts predicted that the Chancellor will breach his debt target. He is forecast to meet the deficit target, but only by a small margin.
Before getting worked up about Osborne failing to meet his target let’s remember that meeting fiscal targets is not inherently noble. It is a means to and end, and that end is long-term fiscal sustainability. It is ensuring that the country’s debt is manageable in the long run. So the real question is whether Osborne’s targets have much relation to that objective.
On the debt target, the answer is ‘no’: debt should start to fall as a percentage of GDP when the country starts to grow, which it hasn’t. Setting an arbitrary date for debt to fall by is not the kind of target that is resilient to unexpected shocks, but nor does missing it mean that debt will become unmanageable. We can still expect that, barring some fiscal disaster, debt will start to fall when growth returns.
On the deficit target, things are a little more complex. Balancing the budget over the business cycle is a worthwhile goal that will then lead to a manageable level of debt. Balancing it within five years is a little more questionable because it allows the Chancellor to plan to balance it every year while never actually achieving the target. Balancing the cyclically adjusted budget adds another layer of complexity that also inhibits the government’s ability to run counter-cyclical fiscal policy.
The problem with cyclically adjusting the deficit is that you need to estimate the output gap: a notoriously difficult task. Because of its importance, the OBR has published a number of papers refining their models for estimating the output gap. In the Autumn statement forecast, as Ian Mulheirn explains here, and I mentioned here, they abandoned those models and revised their estimate from -0.4% down to -2.5%. Had they not done so the Chancellor would have failed to meet either of his targets. Were the output gap as large as some other economists estimate— NIESR estimate -4 to -4.5%—the Chancellor would have achieved his target with room to spare.
This uncertainty illustrates how disconnected the target is from the requirements for long-term sustainability of the public finances. Consequently, the Chancellor may have breached one target and achieved the other by the skin of his teeth, but that really shouldn’t concern us too much. What should concern us is that the targets give very little indication of whether the Chancellor is doing a good job managing the public purse.