Robert Chote, the chairman of the Office for Budget Responsibility.
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The OBR should be given the power to adjust tax rates

Just as an independent Bank of England has helped ensure monetary stability, so a more powerful OBR could ensure fiscal sustainability.

On Wednesday, George Osborne will present his first Budget delivered during a period of economic growth. Despite a deficit forecast to be £111bn and the highest national debt since England last won the World Cup, he is under pressure from both sides of the coalition to reduce taxes, whether on low earners via the personal allowance or middle earners by cutting the higher rate threshold. It is entirely reasonable that politicians are seeking to take advantage of growth forecasts ahead of what will be a closely-fought election. But the last thing the Chancellor can or will do is put further pressure on the public finances via major tax reductions. He will announce improved borrowing projections but he will emphasise that the deficit and debt are the defining challenges, and that they are proving harder to overcome than he expected.

Ahead of the 2015 election, both major parties are jockeying to be seen as the safest pair of hands on the public finances. Both Osborne and Ed Balls have acknowledged the depth of the UK's problems and committed to tough deficit reduction targets. Osborne has pledged to achieve an absolute budget surpus by the end of the next parliament and will introduce a new Charter of Budget Responsibility in this year's Autumn Statement (to  "fix the roof when the sun is shining"), while Balls has promised to run a current budget surplus (leaving room to borrow for investment). 

Short-sighted handling of the public finances has contributed enormously to the economic mess that the UK finds itself in. For the past 20 years, Britain has seen debt steadily climb as successive governments have spent heavily in recessions but failed to save enough in booms. On average, the response to recessions has been 70 per cent greater than the surplus generated in good times. That has lead to a "debt ratchet" that causes debt to rise over each business cycle. Today, the national debt is about £124bn higher than it would have been if the ratchet did not exist.

One reason for the its existence is a persistent overconfidence among politicians and officials. Twenty one of the 25 official forecasts since 2002 have projected that the current budget will return to surplus within five years. When he entered office in 2010, Osborne even adopted that yardstick as one of his two fiscal targets. Yet the budget has not once been in surplus in the past 12 years. 

In 2002, Gordon Brown introduced a set of fiscal rules that the IMF rated as some of the best in the world. The Treasury monitored compliance and the National Audit Office looked over its shoulder. In 2010, Osborne introduced his own, tougher, rules and he looks set to introduce a new rule as part of his Charter of Budget Responsibility. These measures have been the equal of anything seen around the world but all have been broken within a decade and all have been insufficient to avoid the debt ratchet persisting.

One solution that has been exceptionally effective is this government's creation of the Office of Budget Responsibility (OBR), which has dealt with the UK's forecasting problems. Set up in 2010 to resolve persistent errors, the OBR has gradually built its credibility through impartiality and transparency. It has forced the Chancellor to adjust his Budgets on a number of occasions when the numbers did not measure up. So successful has it been that Balls wrote to its chairman Robert Chote to ask him to assess the opposition's manifesto pledges. The Chief Secretary to the Treasury Danny Alexander has since lent his support to the idea.

The expansion in the OBR's responsibilities is a worthwhile first step but it is capable of much more. In future, the OBR could take on responsibility for defining fiscal sustainability and, eventually, the power to adjust tax rates to ensure it. The government recognised that forecasting problems could be largely fixed by passing the responsibility to an independent body. The same may well be true of fiscal sustainability more generally.

The Bank of England is a powerful illustration of how beneficial it can be to delegate operational decisions to an independent, expert body. The Bank's independence ensured that the nation avoided a damaging tightening of monetary policy in the midst of the recession. The same cannot be said of fiscal policy where the latest estimates suggest that consolidation has cost the UK around 3 per cent of GDP so far. That cost might have been avoided if debt and the deficit smaller had been lower when the crisis began.

Successful fiscal councils overseas demonstrate the need to balance responsibility with credibility. The Dutch CPB is an established part of the political landscape and plays an instrumental role in setting budgets and evaluating manifesto pledges. In the US, the Congressional Budget Office assesses alternative policy options for the government. The credibility of these institutions has been built over decades and it would be a mistake to give the OBR too much responsibility too fast. Nonetheless, evaluating manifestos should be the beginning of the OBR's expanding set of responsibilities, not the end.

James Zuccollo is senior economist at Reform

James Zuccollo is senior economist at Reform

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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?