A decade of austerity and growing national debt: why we need to reform the OBR

Last Friday Labour announced that they would reduce the political influence the government can wield over the Office for Budget Responsibility (OBR), a welcome decision. Whilst this move bolsters the OBR’s purpose as an independent fiscal watchdog, it also risks placing an undue confidence in both the methods and aims of it forecasts. The OBR dramatically underestimated the impact of austerity on growth which ultimately led to higher national debt. It does not properly account for the long-term beneficial impacts of investment and spending, meaning we can’t even forecast ourselves out of low prosperity. Fiscal policy shouldn’t just be about meeting fiscal rules, but also about making progress on environmental and social goals. If the OBR is strengthened without reforming what it assesses, then it will entrench short-termism and only focus on fiscal targets. A balanced budget means nothing in an unbalanced society.

“Fiscal policy shouldn’t just be about meeting fiscal rules, but also about making progress on environmental and social goals.”

The OBR provides economic forecasts on the impact of government policy announcements. These forecasts are then used to look at the implications of policy decisions on debt and borrowing, and to analyse whether we are breaching limits defined by our fiscal rules. It’s supposed to be an independent actor, yet recently it’s been marred by political influence. In 2021, the then-Chancellor Rishi Sunak got the OBR to change their forecast timelines to use data that would make the argument for underinvestment in public services easier. More recently, during the Truss-Kwarteng mini-budget, the OBR was forbidden from publishing forecasts of policy effects entirely. The fiscal rules the OBR measures policies against have been changed six times since the Conservatives have been in power. Failure to meet fiscal rules have just seen them scrapped and replaced, shifting goal posts to pretend their economic plans have been working.

But the OBR’s forecasts themselves have also been questionable. Since its creation in 2010 the OBR has underestimated the devastating impact austerity had on the British economy. This is because the OBR does not adequately consider how government spending can have long-lasting effects. Any spending cut (or increase) is assumed to only have temporary effects on the economy. Yet these cuts are why our schools are crumbling, there’s a lack of social housing and our NHS is in crisis. Far from having only temporary effects, austerity adds more pressure to an economy already at breaking point, and ends up costing us more in the long run to fix. We have to fix what is broken, rather than investing in preventative measures.

The US has led the world in its recovery from the pandemic and its response to inflation with billions in stimulus spending. Yet, such a recovery in the UK would be impossible for the OBR to forecast. Along with an inability to model the long-term impacts of economic policy, the OBR also severely underestimates the impact stimulus can have. For example, the OBR uses ​‘fiscal multipliers’ (which measure the impact of government spending on GDP) that max out at 1, meaning in their forecasts the government cannot stimulate more in growth than it spends. Furthermore, with fiscal multipliers under 1 the OBR is assuming that the private sector reduces spending in response to government spending.

“Transparency and independence are important, but we also need a reckoning on our approach to fiscal policy.”

This flies in the face of evidence that fiscal multipliers can be much higher and longer-term, especially when focused on green spending, social progress and public infrastructure. The IMF consistently finds such spending to have multipliers above 1, meaning the economy grows by more than the government spends. And public investment has often been found to encourage private actors to spend more rather than less. By not considering these effects, the OBR does the UK a disservice and will continue to underestimate the transformative potential of fiscal policy.

Therefore, Labour should be careful about embracing the OBR. Transparency and independence are important, but we also need a reckoning on our approach to fiscal policy. Ever-changing fiscal rules and failures to meet targets, with only crumbling schools and longer NHS waitlists to show for it, tells us that our current approach hasn’t worked. However, there are alternatives. At NEF we’ve proposed replacing fiscal rules with fiscal standards, like those proposed by ex-IMF chief economist Olivier Blanchard, set by experts not politicians. Such standards could also combat the asymmetry in how fiscal policies are assessed, while unfunded policies currently raise eyebrows the lack of funding for public services and combatting climate change do not. In this way, fiscal principles would help warn governments of underspending not just overspending.

The UK’s fiscal set-up clearly needs reforming and Labour are right to identify that the OBR’s independence needs reaffirming. But this shouldn’t be the end of fiscal reforms. The OBR’s modelling needs to adequately account for long-term effects and fiscal rules should be scrapped in favour of principles that are more embedded in economic reality. This would allow the government to be much better informed when making fiscal decisions. The end goal shouldn’t be a government ruled by fiscal rules but a government informed by fiscal nous.

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