The OBR, fiscal consolidation and the economy

March 9, 2013 11:24 am

By Sam White

Ouch. The Office of Budget Responsibility has very publicly slapped down the PM.  That’s not something you see every day.

In seeking to explain why “growth has been depressed” in a speech this week, David Cameron claimed the OBR “are absolutely clear that the deficit reduction plan is not responsible”.

The problem is, that isn’t the view of the OBR.

Chairman Robert Chote’s swift response came in a letter to the PM bluntly contracting him: “to summarise, we believe that fiscal consolidation measures have reduced economic growth over the past couple of years”. (my underline)

In my experience of him, Robert Chote has always been credible and measured.  The OBR has moreover shown admirable self-restraint in the face of considerable fast-and-loose behaviour by George Osborne and David Cameron and largely managed to turn the other cheek (I’m thinking particularly of the games played by Osborne to understate long-term tax receipts from the 50p rate).  The fact Robert Chote felt compelled to come out so publicly shows how far from reality the PM’s claims on the economy actually are.

This was not an off-the-cuff remark by the PM; this was part of a prepared speech.  If he wasn’t seeking to mislead people, it means he genuinely didn’t understand his own economic plan.  Neither alternative should fill us with confidence, but the latter would be far more worrying.  Could it really be when George Osborne sold him a political plan to try to get the deficit problem out of the way before the next election, by cutting very early and very fast, Cameron didn’t understand how that would affect the economy?

I hope not.

Politically, the PM is of course seeking to argue everything else is to blame for the lack of growth, except the pace of his fiscal plan.  This continues the theme George Osborne likes to reprise, seeking to blame the weather, the Olympics, the Royal Wedding, Europe, too many days ending with ‘y’ (OK, I made the last one up).

So what’s the underlying economic point?  The question is how much cutting government spending reduces economic growth.  Specifically, for each pound reduction in government spending, how many pounds are you reducing the total size of the economy by?  The so-called ‘multiplier’ – the higher the number, the more harm to the economy from a cut.

The IMF used to say the impact was between 0.4 and 1.2 (i.e. for every £1 cut, it reduced GDP between 40p and £1.20).

The OBR in its letter explains that it is using a range from 0.3 to 1.0 depending on what type of action is taken.  They accept the multiplier effect, but are a little less pessimistic about the downward impact on growth than the original IMF figures.

However, the interesting development last autumn was the IMF revising their view.  The IMF October World Economic Outlook points out that “the evidence increasingly suggests that, in the current environment, the fiscal multipliers are large.”

The IMF go on to say actual multipliers may be higher, in the range of 0.9 to 1.7.”

So the mounting evidence is the impact of cuts on the economy is larger than previously thought, not smaller.

What is so fascinating about David Cameron’s claims yesterday is he seems to be trying to say that the answer is 0.  No impact on growth.

During my time in the Treasury we spent a lot of time with officials thinking about the multiplier effect of government spending.  How much would a fiscal stimulus help the economy during the downturn?  How much would future cuts harm it?  I can’t believe no one has explained how this works to David Cameron.  It would seem an unforgiveable oversight, quite out of keeping with the excellent officials in the Treasury.

So recent evidence suggests the multiplier is bigger than previously thought.  But whatever the precise number is, Robert Chote is clear that “tax increases and spending cuts reduce economic growth in the short term”.  The PM is just wrong to claim anything else.

The OBR estimate the impact has been to “reduce GDP in 2011-12 by around 1.4 per cent”.  And that’s using the relatively conservative multiplier.  It may be a lot higher in the current climate.

The deficit does need to be brought down.  That isn’t the question.  But the timing and manner does matter.  As the IMF’s evidence suggests, ‘in the current environment’ the impact is significant.  You have to have a deficit reduction plan that allows for growth to get going.

This is at the root of the problem with the Osborne approach.  It was always a political plan, not an economic one.  Try and get it done before the next election.  And now, he is ignoring the economic conditions to avoid political discomfort of admitting the plan is not working.

But this comes at a price.  The key thing is that this isn’t some dry economic debate.  This is about the impact on people’s lives.  Many people will be suffering more than they needed to because of the choices this Government has made on the pace of fiscal consolidation.

Sam White was Special Adviser to Chancellor of the Exchequer, Rt Hon Alistair Darling MPmult

  • http://www.facebook.com/thomasleomidlane Thomas Leo Midlane

    “If he wasn’t seeking to mislead people, it means he genuinely didn’t understand his own economic plan. Neither alternative should fill us with confidence, but the latter would be far more worrying.”

    I never get the impression that economics is one of Cameron’s strong points, but surely the spending cuts = reduced growth equation is sufficiently basic for him to have grasped by now. I think the most likely scenario is that he is banking on the fact that most voters lack the knowledge to really engage with arguments over the multiplier, meaning it will be written off as a “dry economic debate” by most. Economically disastrous, but perhaps politically savvy.

    • postageincluded

      You’re right. He’s a natural salesman. The quality and price of the product is irrelevant. He just says whatever he has to say to close the sale.

  • aracataca

    But perhaps the biggest untruth that he uttered on Thursday was the strap line: ‘There is no alternative’.Of course there is. In fact the alternative is at least 70 years old and was outlined by arguably the greatest economist ever, namely JM Keynes. If he had said -‘there is an alternative but I’m not adopting it’- then that is a view that could be respected. His attempt to win crude headlines by uttering a self-evident untruth means that he has shown himself unworthy of political, or for that matter intellectual, respect.

    • Jeremy_Preece

      Yes the desperate attempt to reintroduce Tina “there is no alternative” simply shows someone with nothing to offer, and worse someone who is too blinded by monetrist dogma to even accept that the multiplier exisits.
      We know that the deficit has enabled the Tories manufacture a crisis that will allow them to push for policies that would otherwise never get through, and to use it as a smokescreen to settle all of their old scores.
      Tina is a very sharp contracst form “The good news will keep on coming” which is what we were hearing only at Christmas.

  • trotters1957

    The mistake you are making is to assume that Cameron and Osborne don’t understand, of course they do.
    But their small state dogma means they aren’t bothered, they want to slash the state and privatise all government spending so that government spending can flow through into private hands.
    It doesn’t matter to them what happens to growth or living standards.

  • trotters1957

    The mistake you are making is to assume that Cameron and Osborne don’t understand, of course they do.
    But their small state dogma means they aren’t bothered, they want to slash the state and privatise all government spending so that government spending can flow through into private hands.
    It doesn’t matter to them what happens to growth or living standards.

  • trotters1957

    The mistake you are making is to assume that Cameron and Osborne don’t understand, of course they do.
    But their small state dogma means they aren’t bothered, they want to slash the state and privatise all government spending so that government spending can flow through into private hands.
    It doesn’t matter to them what happens to growth or living standards.

    • aracataca

      Of course if they were genuinely concerned with paying down the debt then why are they hinting at giving away £400 of RBS shares to each taxpayer just months before the election? This particular action is only going to cost the Treasury er………..£14 billion + what looks at first sight to be colossal administrative costs.
      Of course any suggestion that they aren’t really bothered about cutting the debt and in fact are prepared to incur an enormous loss to the national purse in a crude attempt to bribe voters shortly before an election is, and must remain, pure speculation.

    • aracataca

      Of course if they were genuinely concerned with paying down the debt then why are they hinting at giving away £400 of RBS shares to each taxpayer just months before the election? This particular action is only going to cost the Treasury er………..£14 billion + what looks at first sight to be colossal administrative costs.
      Of course any suggestion that they aren’t really bothered about cutting the debt and in fact are prepared to incur an enormous loss to the national purse in a crude attempt to bribe voters shortly before an election is, and must remain, pure speculation.

    • aracataca

      Of course if they were genuinely concerned with paying down the debt then why are they hinting at giving away £400 of RBS shares to each taxpayer just months before the election? This particular action is only going to cost the Treasury er………..£14 billion + what looks at first sight to be colossal administrative costs.
      Of course any suggestion that they aren’t really bothered about cutting the debt and in fact are prepared to incur an enormous loss to the national purse in a crude attempt to bribe voters shortly before an election is, and must remain, pure speculation.

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  • TomFairfax

    Actually the main thing that can be taken from this is that Robert Chote has realised he is going to be out of a job in 2015 unless the OBR starts showing it is really independent and not merely providing ‘evidence’ to justify for George Osborne’s ineptitude. A truly independent OBR should be good for the nation, not the government, regardless of what that geovernment is.

  • TomFairfax

    Actually the main thing that can be taken from this is that Robert Chote has realised he is going to be out of a job in 2015 unless the OBR starts showing it is really independent and not merely providing ‘evidence’ to justify for George Osborne’s ineptitude. A truly independent OBR should be good for the nation, not the government, regardless of what that geovernment is.

  • Brumanuensis

    To be fair, the OBR’s inaccuracies over the years probably come from having a minuscule staff and being chronically under-resourced. They’re nowhere near being a British equivalent of the American Congressional Budget Office.

  • http://twitter.com/renieanjeh Renie Anjeh

    This is why we need a fully independent OBR which can properly monitor fiscal policy, provide traffic-lights on economic policy, launch inquiries on spending and is answerable to Parliament not the Government.

  • AlanGiles

    March 11th: The Conservatives must be getting ever more desperate:

    http://www.bbc.co.uk/news/uk-politics-21737992

    If they think this liar and expenses swindler is their future!

    It sounds as desperate as 2001 when they thought Duncan-Smith was the answer to their prayers. I would suggest a similar rise and fall for Fox if they went down that road.

  • AlanGiles

    March 11th: The Conservatives must be getting ever more desperate:

    http://www.bbc.co.uk/news/uk-politics-21737992

    If they think this liar and expenses swindler is their future!

    It sounds as desperate as 2001 when they thought Duncan-Smith was the answer to their prayers. I would suggest a similar rise and fall for Fox if they went down that road.

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