Written evidence submitted by Simon Hayes,
Chief UK Economist, Barclays Capital
SUMMARY OF
VIEWS
1. The OBR's core duties should be to provide
an independent view of whether the government's public finance
forecasts are "reasonable", and to provide an assessment
of whether the prevailing fiscal stance is consistent with medium-term
sustainability. If resources allow, the remit could be augmented
with a requirement to promote best practice in fiscal policy.
2. The OBR must "own" the macroeconomic
forecasts, and must develop and maintain its own macroeconometric
model. It is not necessary, however, for the OBR to replicate
fully the Treasury's forecasting effort, although the OBR must
have the expertise and access to information to scrutinise Treasury
forecasts of tax and revenue streams.
3. The OBR should not be involved in the specification
of the government's fiscal mandate.
4. The OBR should have its own budget, and
staff should report to, and be remunerated by, the OBR executive.
5. The co-existence of two "official"
forecasts—the MPC's Inflation Report projections and the
OBR's budget forecasts—seems likely to hinder the clarity
with which macroeconomic policy is communicated to the public.
THE OBR'S
REMIT
6. The OBR is potentially an extremely powerful
innovation. Recently, an overseas client asked me whether the
Budget forecast for the revenue gain from switching the indexation
of some government expenditures to CPI from RPI was credible,
or whether it might have been exaggerated. The answer was straightforward:
the decision to make the switch was the government's, but the
forecast for the gain was made by the OBR. The OBR's independence
nipped any hint of impropriety in the bud.
7. I believe the OBR should have two core duties:
— To provide an independent view of whether
the government's fiscal forecasts are "reasonable".
— To provide an independent view of whether
the prevailing fiscal stance is consistent with medium-term sustainability.
8. The purpose of these duties is to keep
the government "honest" and "informed" and
thereby to enhance public confidence in the management of the
public finances.
9. Having the OBR produce the budget forecasts
is an effective way of hard-wiring the first of these into the
system, but it is not the only way. Fundamentally it is the OBR's
sign-off, and the perceived independence of the sign-off, that
are crucial, rather than the source of the forecasts. From this
perspective I do not think it necessary for the OBR to replicate
fully the forecasting effort of the Treasury. It makes sense for
the OBR to "own" the macroeconomic forecast, but the
detailed tax and revenue forecasts could be provided by the Treasury
and other relevant government departments. The OBR must, however,
have the ability (the expertise and the access to information)
to scrutinise these forecasts.
10. There has been some debate about whether
the OBR should comment on the fiscal "mandate"—which
I take to mean the government's stated goals for the public finance
dynamics. I see no reason why the OBR should be involved in the
specification of the mandate. In fact, I think there may be a
danger in the OBR becoming associated with any particular mandate:
there should be no suggestion that the OBR has an incentive to
produce forecasts that show that the mandate is likely to be supportive
of growth, for example. Of course, the OBR will be commenting
implicitly on the mandate through its growth forecasts and its
sustainability assessment: this is, after all, its fundamental
raison d'être.
11. The remit could be extended to give
the OBR a more substantive role in framing the debate about the
appropriate configuration of fiscal policy. For example, the OBR
could be asked to assess the likelihood of meeting the mandate,
or to produce analysis of fiscal "good practice" and
fiscal "bad practice" against which existing or prospective
government policies could be compared. The benefit of broadening
the OBR's remit along these lines would be to help raise the quality
of debate about the appropriate setting of fiscal policy. However,
I would see this as a "nice-to-have" rather than a "must-have"
feature of the set-up. So, for example, although the government
of the day may wish for the OBR to provide an assessment of the
likelihood of its mandate being met, as the current government
did in June, I do not see this as a necessary OBR function and
I would see no need to specify it as a core duty.
12. If the resources were available for
"nice-to-haves" I would suggest giving the OBR an additional
duty of promoting best practice in fiscal policy. The idea would
be to improve the understanding, primarily among political leaders,
of the economic efficiency arguments for and against certain tax
and spending policies. The government, and opposition parties,
might be encouraged to ask the OBR for independent assessments
of prospective policies.
MEANS OF
ASSURING INDEPENDENCE
AND ACCOUNTABILITY
13. I have nothing to add to existing suggestions
for the Budget Responsibility Committee (BRC): I think three people
is the right size, that appointments should be made in a similar
way to those of external MPC members and that the Treasury Select
Committee should scrutinise the appointments.
14. The OBR must have its own budget, preferably
set in advance for a fixed period out of synch with the electoral
cycle (eg a five-year budget set three years into each parliamentary
term) or according to a pre-specified formula.
15. I think it is important that OBR staff
report to, and are remunerated by, the BRC. Given the limited
supply of relevant expertise it makes sense to allow staff to
move between the OBR and the Treasury. This raises the concern
that OBR staff might have an incentive to produce assessments
that are viewed favourably by the Treasury in order to keep their
career options open. I think this is a legitimate concern, but
short of barring staff from crossing over I see no obvious solution.
(A similar tension is likely to exist at the Bank of England,
between the "internal" Monetary Analysis area and the
MPC Unit, which services the external MPC members. It may be worth
consulting with the Bank of England to gauge whether it is viewed
as a material problem and whether there are measures that can
be taken to minimise it.)
APPROPRIATE RESOURCES
16. Although it is difficult to take a strong
view of the appropriate level of resourcing at this early stage,
as a ball-park figure I would envisage the OBR as having a permanent
staff of around eight analysts to cover the two core duties set
out above. This is a little larger than the Bank of England's
core forecast team, I believe, and certainly larger than the UK
economics teams in the City, which typically comprise two to three
analysts. The need for a larger forecast team at the OBR stems
from the greater complexity needed to produce/scrutinise tax and
revenue streams at a detailed level.
17. If the OBR is to own the macroeconomic forecasts
it needs to develop and maintain its own macroeconometric model.
There is a set-up cost associated with this but it need not be
an onerous one. Diminishing returns quickly set in with macroeconomic
forecasting—the accuracy gains from increased sophistication
are questionable beyond a basic level—and the Treasury model
should provide a suitable baseline. In any case, I would imagine
that the OBR's forecasts are unlikely to stray far from the consensus
view: to a large extent it has been HM Treasury's propensity to
publish macroeconomic forecasts that were some way different from
the consensus that gave rise to concerns about the plausibility
of budget projections in the first place. Indeed, I would think
the OBR should maintain a constant (two-way) dialogue with other
forecasters to gauge how its views are evolving relative to the
consensus. It may also be beneficial in the medium term to encourage
movement between the forecast teams at the OBR and the BoE.
18. I think that the OBR should be strongly
encouraged to draw on outside academic expertise, engaging in
joint research projects on ad hoc issues relating to macroeconomic
forecasting and sustainability analysis.
A SINGLE "OFFICIAL"
MACROECONOMIC FORECAST?
19. One broader concern I have is with the
communication of macroeconomic policy when there are two "official"
economic forecasts—the MPC's Inflation Report projections,
which form the basis of monetary policy, and the OBR's budget
forecasts, which underpin fiscal policy. If the two forecasts
are materially different, it will be difficult for the authorities
to argue that monetary and fiscal policy are appropriately co-ordinated.
If they are engineered so as not to be materially different, it
raises the question of why effort is being duplicated across two
public institutions.
20. It is easy to see circumstances in which
the MPC and the OBR might produce materially different forecasts
of the economy. For example, assessments of the level of the output
gap, and the economy's "trend" rate of growth, are key
inputs into both monetary policy and fiscal projections and yet
there is no consensus in the economics profession about how to
measure either. The OBR is currently assuming that trend growth
is around 2-2.25% per annum: although the MPC tends to be reluctant
to disclose its trend growth assumption, the indications are that
its baseline assumption is that trend growth is faster than this—around
2.5%. If the MPC is right, the OBR is too pessimistic about the
medium-term public finance outlook. If the OBR is right, the MPC
is too optimistic about the inflation consequences of its growth
projections. This is not a wholly satisfactory state of affairs.
21. Some would argue that this was not an
issue in previous decades when policy was set with reference to
different forecasts in different parts of government. However,
forecasts have taken a much more central role in policymakers'
communication efforts in recent years—in no small part because
of the MPC's use of the Inflation Report projections as a communication
device.
22. Note also that this is primarily a point
about communication rather than about policy itself. Even within
the MPC, members will have different views about the plausibility
of the central Inflation Report projections and their policy votes
will reflect their personal assessment of the outlook. This freedom
lies at the heart of the principle that nine independent experts
should, on average, make better judgments than a consensus view.
However, the Inflation Report projections are used as way of communicating
the MPC's "best collective judgment" to the public at
large, and so it is perfectly reasonable for the public to ask
how the MPC's assessment squares with that of the OBR and what
the implications are of the forecasts being different.
23. At best, this introduces noise into
the policy debate: at worst, differences in the assumptions underlying
the forecasts make any claims of consistency or co-ordination
implausible, and this could be harmful to the credibility of the
overall framework. I think this concern argues for the OBR co-ordinating
closely with the Bank of England to ensure a high degree of congruence
between the forecasts—but it also raises the broader question
of whether a single "official" projection is desirable
for the purposes of communicating macroeconomic policy.
ABOUT THE
CONTRIBUTOR
24. Simon Hayes is the Chief UK Economist
at Barclays Capital, the investment banking arm of Barclays Bank.
He is responsible for formulating the company's view on the outlook
for the UK economy, including monetary and fiscal policy. Simon
joined Barclays Capital in 2005 after eight years working at the
Bank of England. Simon has a BA in Economics and a PhD from Newcastle
University, and an MSc in Economics from Warwick University.
August 2010
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