Markets take OBR seriously because it takes them seriously

I know the Lease Truss never actually happened used The phrase ‘leftist economic establishment’ during his current comeback tour. Some are overzealous The Daily Telegraph Saab turned his simple sentiment into a phrase that launched a thousand tweets. Still, it can’t be denied that the former prime minister has noticed a “conventional bigotry” with which he disagrees – and the Office for Budget Responsibility (OBR) has come in for some stick.

His bugbear is the OBR’s economic model on which to base “assumptions”. Its forecast, he argues, is not “dynamic enough”. The potential benefits of his tax cuts for growth and revenue were ignored. The “direct correlation” between the OBR forecast “and the market” meant his challenge to orthodoxy scared off financiers, undermined his plans and forced him out of office.

Does he have a point? To determine, we should examine why OBR was established. Followed by George Osborne in 2008 after the financial crisis, it was officially created in May 2010. It aims to provide independent assessments of the UK’s public finances, making forecasts consistent with fiscal events. Like the awkward group photos outside number 11, its reading The Sibylline Book Budget has become an accepted part of the day’s routine.

So it should be remembered that the OBR was the target of some derision when Osborne first proposed it. Politically, Osborne saw this as an effective shield for the Conservatives’ efforts to cut spending – if the OBR, faithful to being independent, called for cuts to reduce the deficit, then ‘austerity’ became the dispensing of economic medicine rather than the Tories. Zeal to shrink the state that the left will draw on.

Yet this was not an unhappy child of Osborne’s enthusiasm for triangulation. There has been a clear economic benefit to the body. Prior to 2010, budget forecasts were produced by the Treasury. Naturally, those involved will strive for accuracy.

But that was under Gordon Brown. Forecasts under the ‘Iron Chancellor’ had an uncanny knack of fully vindicating his approach on Budget day, before the latter was deadlocked. Brown could get away with it during the boom years, but not when the bust came.

As someone involved in the creation of the OBR told me, its subtle impact on the numbers has knocked market confidence in our forecasts, made our borrowing costs higher than they otherwise would have been, exacerbated the recession’s blow to our public finances, and made spending restraint more necessary.

OBR was designed to prevent recurrence. It ensured that public finances were sustainable by providing an independent check on the credibility of the government’s plans. But even of mice, men and the best laid plans of the past Evening Standard Editors were not ready for trosonomics.

In Truss’s defence, it’s worth noting that Osborne’s view represented a broader – sigh – bigotry. As our editors highlight, the consensus in fiscal and monetary policy circles after 1979 was for public finance to match public spending with public finance and taxation. With the Bank of England controlling inflation, the chancellor’s job was to ensure debt remained stable or fell as a proportion of GDP.

New Labor claims to have signed up for it. Brown stuck to the Tories’ spending plan, running several years of surpluses and reducing government debt. But blessed with a second landslide in 2001, Brown began borrowing instead of balancing the books. He ran deficits between 2002 and 2008, masked by solid growth. This left us dangerously exposed when the crash came.

In response to the recession, he ditched Keynes and doubled the debt from 35.3 percent to 66.3 percent of GDP. It did little good for growth. Since 2008, productivity has grown at an annual rate of 0.4 percent.

By 2022, the OBR has long successfully moved politics out of economic forecasts. But Boris Johnson was caught with some cake, Chris Pincher had too much sherry at the Carlton Club and members of the Tory party made sure Liz Truss turned 55.m Prime Minister. He quickly announced his energy bailout package with little market reaction.

Truss premiership unfolds after Kwasi Kwarteng announces their mini-budget without a caretaker OBR, one will be a long time to wait. After the fall of the pound, rising bond yields, the pension crisis, the Bank of England intervention, the screaming U-turn and his final defenestration, which appears to have been a faux pas.

But the OBR – or, more accurately, excessive market anxiety over the lack of a forecast from it – was not responsible for the market’s reaction to his Chancellor’s mini-budget. The central reason was the market’s lack of trust in taxonomics.

The mini-budget unleashed the biggest “dash to growth” since the barber boom in a feverish market environment where fiscal policy was tightening and energy costs were volatile – and did so without an accompanying policy of spending cuts. Indeed, Truss maintained that spending throughout the campaign and in office will not to cut

Like Brown in 2008, Truss broke with the post-Thatcher orthodoxy that tax cuts should be accompanied by spending cuts. Unlike Brown, Truss and Kwarteng were out on a limb—not swimming with an expansionary tide, but promising to borrow more as it was becoming more expensive to do so.

Or OBR will say. Trasonomics stalwarts will argue that ‘orthodoxy’ underestimated how much its tax cuts would raise revenue – part of a larger failure to make forecasts sufficiently ‘dynamic’ and aware of the Laffer Curve. Yet to say that OBR does not do ‘dynamic’ modeling is a fantasy.

When Osborne cut the top rate of income tax in 2012, ‘static’ modeling suggested a big fall in revenue. But the then chancellor gave evidence to the contrary and the OBR adjusted its forecast to suggest a revenue reduction of just £100 million. Truss and Kwarteng chose not to do the same for their mini-budgets. Instead of making their case to the OBR, they ignored it in their haste to implement their agenda.

Some of their claims – that, for example, removing the increase in corporation tax would generate more revenue – were not believed. Of course, OBR’s metrics are determined by politicians. If Truss and Quartet had wanted to adjust them so that the government was no longer interested in reducing debt as a proportion of GDP, they could have done so. What they shouldn’t have done was cut taxes, maintain public spending and reduce debt.

Markets are not stupid. They take OBR seriously because it takes them seriously. If the government wants to borrow to spend, it has to accept the market environment in which it does so. A decade of loose monetary policy hasn’t changed that. Dissatisfaction with its lack of predictability shows the credibility it has built over the past decade.

Economic models are not perfect. No attempt is made to predict the future. But governments, markets, businesses, and families must plan against something. And an organization like the OBR has far more credibility in its economic forecasts than the Trus.

Why? Because it’s his cake and he doesn’t try to eat it. The OBR suggests that balancing borrowing, spending, debt and taxation actually has to be chosen, even if politicians don’t. It counts just as much when the challenge comes from trying to start a free-market revolution as it does from Brown’s fusing of boom and bust.