House of Commons - Office for Budget Responsibility

Office for Budget Responsibility - Treasury Contents

1 Introduction

The interim Office for Budget Responsibility

1. On 17 May 2010 the Chancellor of the Exchequer announced the formation of an interim Office for Budget Responsibility (OBR), led by a Budget Responsibility Committee (BRC). The interim Committee was chaired by Sir Alan Budd, a founding member of the Monetary Policy Committee, and also comprised the economists Geoffrey Dicks and Graham Parker CBE.

2. The primary task of the interim OBR was to make two independent assessments of the public finances and the economy: one based on current policy prior to the June 2010 Budget and one at the time of the Budget, incorporating its measures.[1]

3. The interim body's terms of reference also required it to:

have a role in beginning an independent assessment of the public sector balance sheet and fiscal sustainability;
judge whether Government policy was consistent with a better than fifty per cent chance of achieving the fiscal mandate set by the Chancellor of the Exchequer;
provide advice to the Chancellor on the permanent OBR's roles and responsibilities, aims and objectives, and appropriate size, status and funding; and
be accountable to Parliament for the delivery of its tasks.[2]

4. The interim OBR produced its pre-Budget forecast on 14 June 2010. Its Budget forecasts formed part of the Budget documents, published on 22 June 2010. On 6 July Sir Alan Budd announced he would be stepping down as head of the OBR. The OBR published its advice to the Chancellor on the formation of the permanent OBR on 12 July 2010 and the Chancellor responded shortly afterwards.[3]

5. This Committee was established on 12 July 2010. We immediately agreed to undertake a short inquiry into the structure of the permanent OBR. We took evidence from Sir Alan Budd and the other BRC Members at our meeting on 20 July and on 22 July from three experts in the field: Robert Chote, Director of the Institute for Fiscal Studies, Professor Timothy Besley, of the London School of Economics, and Professor Simon Wren-Lewis, of the University of Oxford. We also received 17 written submissions. In addition, we discussed the OBR in our budget hearings with Treasury officials and with the Chancellor of the Exchequer. We are grateful to all those who took time to contribute to our inquiry and particularly grateful to Sir Nicholas Monck KCB, for acting as specialist adviser.

The work of the interim OBR

6. The interim OBR produced two forecasts in the run-up to a Budget which came less than seven weeks after the election. As the Chancellor described, its work is being applauded by the OECD and the IMF.[4] The OBR's involvement in the forecast has already led to significant changes in approach, summarised in the Foreword to the pre-Budget forecast:

The first is our stress on the uncertainty of the forecasts, particularly of the fiscal forecasts. We illustrate this principally by the use of fan charts. The second is that we have based the range of fiscal outcomes around our central view of prospects. The previous Government used deliberately cautious assumptions for some key variables in its fiscal projections. We have departed from that practice and, as we have said, have used other methods to illustrate uncertainty. Finally, we have provided more detail than hitherto in relation to the fiscal forecasts. This improvement in transparency will, we hope, make it easier for commentators to understand our forecasts and should provide them with more information if they wish to make forecasts of their own.[5]

7. The OBR has also been far more transparent in the information it gives, and its explanation of its judgement. Giving evidence at the time of the June Budget, Mr Ramsden, the Government Chief Economic Adviser, told us:

it is worth stressing that what underlies all the OBR's forecasts is its commitment to transparency. I have been working on forecasting in the Treasury and the economy for 20 years and I think the OBR has made more progress on transparency in the last eight weeks than in my experience of 20 years working on forecasting and the transparency that goes with it. They have set out very clearly their assumptions and their judgments on the forecast and on the degree of rebalancing that they judge there will be.[6]

8. The interim OBR produced a Pre-Budget report and a Budget report in a very short space of time. It has increased the transparency of the forecasting process. Members of the Budget Responsibility Committee came to give evidence to us twice, and were exemplary witnesses. We wish to put on record our appreciation of the interim OBR's work, and, in particular, of the leadership given by Sir Alan Budd, Geoffrey Dicks and Graham Parker.

The current proposals for an independent OBR

9. The OBR has produced its advice on the structure of the permanent body. In summary, the OBR advised that:

the OBR should produce forecasts for the economy and public finances;
forecasts should be produced at least twice a year and include the official Budget forecast;
the OBR should undertake broader analysis of fiscal sustainability;
the technical independence of the OBR should be enhanced through the transfer of analytical capacity from the Treasury to the OBR;
the OBR should employ a mix of external recruits and staff from the Treasury to produce forecasts and analysis;
Parliament should have a role in the appointment of the members of the Budget Responsibility Committee; and
the OBR should be located outside the Treasury building.[7]
The Chancellor broadly accepted that advice (which largely reflects proposals he made in opposition) when he set out his thinking in a letter to the Chair of this Committee published with our Report.[8]

Independent forecasting

10. The Office for Budget Responsibility was established against a backdrop of a widening public sector deficit and a related rise in public sector indebtedness following the global economic crisis and the economic downturn. There is growing academic scepticism about the objectivity of successive government economic forecasts and a lack of clarity about the full-scale of public sector liabilities.[9] The OBR has been created to address the latter two issues.

11. The problem of how to ensure that forecasting is, and is seen to be, objective, and fiscal policy is responsible is a long-standing and difficult one. Some parallels have been drawn with monetary policy. There is a precedent for giving an independent body power to undertake economic policy functions on behalf of the Government in the shape of the MPC, which has the responsibility to conduct monetary policy in a way which ensures that the Government's inflation target is met. However, there are profound differences between outsourcing monetary policy in this way and outsourcing the forecasting process.

12. The MPC has a clear policy objective, with a measurable target and control of the instruments to achieve it. If the inflation target is breached, the Governor has to explain to the Government, the Treasury Select Committee and the public. In contrast, the OBR provides a forecast and commentary; it has no responsibility for policy on which it comments or which its work may influence internally. This requires the exercise of particular care and restraint by the OBR.

13. Moreover, the MPC is part of an existing organisation with considerable resources, which is not directly dependent on government for those resources. The OBR is a new institution, founded at a time when spending is severely constrained, which has no existing institutional expertise on which to draw. The previous Government wished to improve monetary policy-making by giving control of interest rates, within a policy framework set by Government, to an independent Bank of England: the current Government aims to improve fiscal policy making by giving responsibility for forecasting to an independent body. It is a bold step. However the MPC has a clear task and controls the means to achieve it. The OBR has a more complex relationship with government.

Independent fiscal councils

14. Announcing the creation of the OBR in May 2010, the Chancellor said that the body would:

ensure credible official economic and fiscal forecasts by removing the perceived ability of Chancellors to "fiddle the figures";
assess the feasibility of the Government's fiscal targets; and
provide an independent, objective and comprehensive assessment of fiscal sustainability.

The Chancellor argued that these measures would restrict the ability of governments to pursue unsustainable fiscal policies in future.[10] In adopting this approach, the Chancellor effectively established the OBR as an independent fiscal council, a term adopted to describe a variety of bodies intended to bring some independent assessment to economic and fiscal policy.

15. Although the United Kingdom is an early adopter of the independent fiscal council, several institutions which perform some of its functions already exist. Professor Simon Wren-Lewis of Oxford University notes that macro-economists have become interested in such bodies "as a possible antidote to deficit bias: the tendency for government debt as a proportion of GDP to rise over time that has been observed in the OECD area as a whole."[11] Professor Wren-Lewis has offered a range of reasons why a fiscal council might counteract this bias:

By making fiscal positions more transparent, they may prevent governments deliberately concealing the extent of future deficits implied by current policies, or prevent governments being overoptimistic about their finances. The public may have insufficient information to differentiate between governments that are more efficient at managing spending, and those that pretend to be in order to win votes through spending increases or tax breaks. A fiscal council could help provide that information.
Because governments in a democracy may not be re-elected, there may be an incentive for them to discount the future heavily. [...]
In the previous cases, if the public had full information and could discipline governments, deficit bias would not arise. An alternative reason for deficit bias is that the public may be selfish, in the sense that they attempt to exploit future generations, or they may be unable to resist immediate temptations. A fiscal council could attempt to apply political pressure on behalf of future generations, or provide moral pressure to discount the future less heavily. They may also prevent politicians pandering to these tendencies.[12]

16. Fiscal councils do not follow a single model, and vary both in their tasks, and in the degree of their separation from the executive. However, all are intended to improve economic and fiscal policy making by ensuring that there is a degree of independent technical scrutiny of the Government's proposals. An outline of arrangements for other fiscal councils is contained in Annex 1.

17. The primary function of the interim OBR was to produce the macroeconomic and fiscal forecasts prior to and alongside the June 2010 Budget. The Chancellor has confirmed that the permanent OBR will continue to produce official fiscal and economic forecasts, although he will have the right to disagree with those forecasts when making policy.[13]

18. Existing fiscal councils range from extremely small groups which are concerned with simply validating the Government's forecast and assumptions, to much larger bodies which may produce forecasts themselves, conduct economic research and publish commentary. The mix of tasks can vary widely. The US Congressional Budget Office (CBO) is the largest fiscal council. Its core work includes producing:

a twice-yearly baseline projection of the economic and budgetary outlook over the next ten years;
an independent estimate of the President's budget proposals, including comparison of the CBO's estimates with those of the administration;
analysis of the spending and revenue effect of specific legislative proposals;
an annual report on the long-term fiscal outlook; and
an annual volume discussing the arguments for and against possible budget options.

Established under statute, the CBO assists the House of Representatives and Senate by producing "objective, nonpartisan and timely" reports and analysis. In keeping with this remit the CBO does not produce policy recommendations. Similarly, the CBO's long term projections provide a baseline which "is constructed according to rules set forth in law, which generally instruct CBO to assume that current spending and revenue laws continue without change. Thus, the baseline is not a prediction of future budget outcomes. Rather, it reflects CBO's best judgment about how the economy and other factors will affect federal revenues and spending under existing laws."[14] In contrast to the CBO, which received $45.2 million in funding in 2010 and employs around 250 people, the Swedish Fiscal Policy Council consists of eight members and is assisted by a secretariat with four employees.[15]

19. While it is usual for fiscal councils to be concerned with making it difficult for governments to avoid or postpone necessary but unpopular decisions to stave off threats to fiscal sustainability, most fiscal councils do not themselves produce the forecast which the government uses in making its fiscal judgements.[16] More often they produce an assessment of the official forecast (or an alternative forecast of their own) following its publication.[17]

20. Fiscal councils also differ widely in their relationship to Government and Parliament. The CBO in the US and the Parliamentary Budget Office in Canada are linked to Parliament. The Economic Council of Denmark contains representatives from many groups—unions, employers, the central bank and the Government. The Netherlands Bureau for Economic Analysis (CPB) describes itself as "a research institute that is independent with respect to content, but at the same time CPB is formally part of the central government."[18]

21. There are advantages and disadvantages to every type of organisation. The simple validation model can help to reduce the danger that a fiscal council's independence may be called into question; however, given developments in recent years in the United Kingdom, it may not be enough to ensure confidence in a government's forecast. An organisation which produces the government's forecast may be felt to be too close to that government, or, conversely, may have to operate at such a distance it cannot effectively draw on government information.

22. Given these difficulties, it may be hard to design a fully independent forecasting body responsible for producing government forecasts, unless there is significant duplication of expertise between the forecaster and the Treasury. This would be costly. We note that there are many views as to the appropriate tasks for the OBR, and for its remit.

23. The Government has taken a significant step, which is not without risks, in seeking to give an independent body responsibility for the forecast. Official forecasts may influence expectations. The benefits of surrendering control over the forecast can only be achieved if the OBR's independence is beyond doubt and its competence is established. The OBR will have to demonstrate a commitment to transparency, objectivity and impartiality over a sustained period if it is to command and retain public confidence.

24. In this Report we examine some of the ways in which the independence of the OBR can be fostered, but one key factor, for which it is impossible to legislate, will be the quality of the organisation's people, and of the work they produce. The interim OBR, led by Sir Alan Budd, made an excellent start on which the permanent body can build.

25. Like any structure for an independent fiscal council, the model that the Chancellor has chosen for the OBR has its own advantages and disadvantages. Placing the entire process in the hands of a single body ensures a clarity of process and responsibility between government and the OBR that would be lacking were there rival forecasts.[19] Robert Chote argued that the OBR as constituted by the Chancellor would reinforce the ability of Treasury officials to provide objective advice to ministers.[20] Similarly, the OBR's direct involvement in the Budget process means it is in a more influential position during the policy-making process than it would be as an external commentator. As Sir Alan Budd told us:

the Chancellor when he is considering policies must be considering their effect on the economy and it is the OBR who tells him, as best they can, what the effect on the economy of those policies will be, so to that extent the OBR does become a very important part of the budget decision-taking process.[21]

26. Adopting the OBR forecast has meant that the OBR and the Treasury have needed to work closely together on the budget: in evidence to the Committee, Sir Alan Budd maintained:

If one of the core activities of the OBR is to produce on Budget Day a fully articulated fiscal forecast with all the detail provided in the Red Book, then the involvement of officials working in the Treasury, HMRC and DWP is absolutely inevitable. They command the detailed knowledge of the policies and programmes; they work on the policy changes, if any; and they are the experts on the effects of those policy changes.[22]

Involvement in the Budget process necessarily involves close contact between the Treasury and the OBR, whilst drawing up official forecasts is likely to involve some dependence on government resources.[23] Both of these have been seen to weaken the OBR's independence and are not easily resolved, as we shall see.[24]

27. There are three key interrelated factors to consider when deciding how to make sure an organisation such as the OBR is effective:

the tasks it should undertake;
the resources it needs to carry out those tasks;
its institutional structure, accountability and discretion;

28. There is no "correct" model for an independent fiscal council; each arrangement will have its own advantages and drawbacks. In this Report we do not conduct an exhaustive examination of the various ways in which a fiscal council could be structured but focus on the Government's proposals and how they can be made to work.

29. The OBR's contribution to the formulation and improvement of public policy will be made through the substance of its work, which over time, can contribute to greater public confidence in fiscal policy making. It must avoid the trap of convincing itself (and consequently convincing the general public) that it or any other body has a monopoly of wisdom on short term forecasting, which is an inherently uncertain process. The OBR can only be effective if it is independent. Our proposals are designed to strengthen the OBR's independence, and the perception that it is independent, notwithstanding its involvement in drawing up the Government's forecast.

30. The OBR should avoid being drawn into seeking to apply political pressure through its commentary—even though many commentators will encourage it to do so. The OBR, is not and should not be, running fiscal policy.

31. This Committee will have a key role both in holding the OBR to account and in upholding its independence. The NAO audited OBR independence at the time of the Budget and identified the following criteria by which the independence of the judgement underlying the forecasts could be judged:

The Budget Responsibility Committee had full discretion over the scope and nature of its judgments on the forecasts.
The interim Office for Budget Responsibility had unrestricted access to the necessary data and analysis.
The interim Office for Budget Responsibility had control over sufficient resources to consider the evidence and form a robust judgment.
The interim Office for Budget Responsibility effectively scrutinised, questioned and challenged the information and advice it received.
The Budget Responsibility Committee formed its judgments independently of any views of officials or Ministers.
The Budget Responsibility Committee had autonomy over the content of its published reports and the means of dissemination.[25]

We consider that these criteria provide an excellent foundation by which to judge the future OBR, and will bear them in mind in our future work.

32. In this Report we have started from the framework proposed by the Chancellor: the OBR will be a new body, and it is reasonable to see whether those arrangements can be made to work. However, given the lack of institutional experience of bodies such as the OBR, and the range of views on the matter, we consider that the arrangements adopted for the permanent OBR should be subject to comprehensive review no later than five years after it is established by statute.

33. The review should include an assessment of the OBR's performance, remit and institutional accountability arrangements. In particular, we believe that the review should consider in the light of experience the case for the OBR becoming a Parliamentary body with its resources determined by a House of Commons body, such as the Public Accounts Commission.

34. This review should be carried out by a small team of external experts, possibly commissioned by the National Audit Office, and should report to us as well as to the Chancellor. This Committee should be consulted both about the scope of the review and about the arrangements for carrying it out.

1 Terms of Reference for the interim OBR: http://www.hm-treasury.gov.uk/d/obr_terms_of_reference_080610.pdf accessed 17 August 2010. Back

2 Ibid. Back

3 ^Ev30 Back

4 Ev 30, para 2 Back

5 OBR, Pre-Budget Forecast, June 2010 Back

6 Treasury Committee, First Report of Session 2010-11, June 2010 Budget, Q141 Back

7 Advice on the Permanent Office for Budget Responsibility, http://budgetresponsibility.independent.gov.uk/ d/obr_permanent_body_advice_120710.pdf Back

8 Ev 30 Back

9 Ev w15, para 3 [Dr George Kopits]; Ev w6, para 3 [NIESR], Ev w10, para 11 [ICAEW] Back

10 Speech by the Chancellor of the Exchequer, 17 May 2010, http://www.hm-treasury.gov.uk/press_02_10.htm accessed 17 August 2010 Back

11 Fiscal Council's web: see footnote 11. Back

12 http://www.economics.ox.ac.uk/members/simon.wren-lewis/fc/fiscal_councils.htm#_Frequently_Asked_Questions Back