When Rachel Reeves made her speech as shadow chancellor to Labour’s annual party conference two years ago it was one of the more niche announcements that drew a cheer from the audience.
Strengthening the role of the Office for Budget Responsibility might have sounded like a dry measure to unveil to the party faithful. But, after the Liz Truss debacle, handing the Treasury watchdog more powers went down a storm in Liverpool.
Next week will be a different story. On Wednesday Reeves, now as chancellor, will present her spring statement to the Commons in response to OBR forecasts that are widely expected to show her self-imposed fiscal rules would be broken without action, providing the momentum behind the government’s benefit cuts and plans to choke off other spending.
Driving the chancellor is a rise in government borrowing costs, weak economic growth and stubborn inflation which are expected to have wiped out all of the £9.9bn headroom she left in October against her main fiscal rule – requiring day-to-day spending to be matched by spending receipts within five years’ time.
Things could have been different. This week the former Bank of England deputy governor Charlie Bean warned the chancellor against making kneejerk cuts. A “more adult way of proceeding”, he said, would be to allow the rules to be breached with a small miss and acknowledge that forecasts can be volatile. That ought to be no big deal, he said. Even if there were concerns, Reeves could take corrective action in less than three months’ time at the spending review, or at the autumn budget.
“That said, simply saying that probably won’t cut the ice at the current juncture – and in particular given her credibility personally has probably been somewhat weakened,” said Bean, who is also a former member of the OBR’s budget responsibility committee.
Part of the issue is that Reeves has clung tightly to her “non-negotiable” fiscal rules, and promised not to repeat anything on the scale of last October’s tax-raising budget, leaving spending cuts as the path of least political resistance. The chancellor has set significant credence in keeping the OBR on side in particular.
But the mood is turning in Labour circles, much of it stemming from the tight involvement of the OBR in policymaking. “People are feeling pretty gloomy right now. And there is no sign of anything getting better either,” said one source close to the party. “We have a loop where you get two forecasts [a year] and one budget. It’s a nightmare for political management.”
There is precedent for the fiscal rules to be breached. George Osborne, the OBR’s architect in 2010, broke his rules in 2012 and 2016. The targets have been changed repeatedly: at least eight times since 2010, giving them the shortest lifespan of any major government’s fiscal rules.
Part of the problem for Reeves was leaving one of the smallest amounts of headroom against her fiscal targets of any chancellor in the past 15 years. While £10bn might sound like a lot, set against a £2.6tn economy and a government that spends more than £1tn a year, economists say a miss is far more likely.
Jagjit Chadha, a professor of economics at the University of Cambridge, and the former director of the National Institute of Economic and Social Research, said there was a clear case for allowing the rules to be breached.
“If the weather is bad you might want to approach the destination in a different manner to going straight up the mountain in front of you. They don’t have to be slavishly followed,” he said.
“They could establish credibility with the market without hitting that target exactly. The Bank of England has not hit its 2% inflation target every day. Why should that be any different for fiscal policy?”
The Treasury is concerned, however, that allowing a breach would bring the risk of a repeat of Truss’s mini-budget, at a time when government borrowing costs have risen sharply – linked to global conditions, but also investor worries about the UK’s domestic situation and the government’s already high levels of borrowing and debt.
“It has not rolled the pitch for a small miss. It’s rolled the pitch for the rules being ‘ironclad, non-negotiable’,” said Andy King, a former OBR member who is now a specialist partner at the advisory firm Flint Global.
“I get the sense there is concern if they were to take the fiscally easy option then that signals they’re not serious about the deficit.”
Before the OBR, the Treasury previously made its own forecasts for the economy and the public finances, allowing it to potentially produce overly optimistic figures. Back at its inception in 2010 Osborne said the OBR would leave “no way to fiddle the figures, and no way of avoiding the difficult choices that have been put off for too long”.
The underlying message was the OBR was required after this type of practice in the Labour years, as the Tories sought to blame Gordon Brown’s government for the 2008 global financial crash.
Under the rules Osborne introduced, the chancellor must commission two forecasts per year, one of which will be for the budget. The process involves the OBR providing an initial forecast, which the Treasury then responds to with any policy measures it wants to announce, which the watchdog then incorporates into its economic and fiscal outlook report.
From its vantage point in an ivory, concrete tower at the top of the Ministry of Justice’s brutalist headquarters in Whitehall, the watchdog passed the final round of forecasts on Friday to the Treasury on the opposite corner of St James’s Park.
Five rounds of forecasts pass between the Treasury on Horse Guards Road and the 14th floor of the building once known as “the Lubyanka” by Blair-era ministers, after the KGB’s notorious Moscow headquarters, in a process that intimately involves the watchdog with tax and spending policy development.
In the run-up to the spring statement a phrase that crops up time and again in Treasury circles, to the point of obsession, is: “Does it score?”
The term refers to whether a particular tax or spending announcement will be included in the OBR’s forecast “scorecard”, which sets out whether the change will positively or negatively affect the public finances.
At risk of breaking her fiscal rules, Reeves had a bigger incentive than usual to develop policies meeting this test.
It is understood this tension drove a wedge in particular between the chancellor and Liz Kendall, the work and pensions secretary.
Ahead of the government’s welfare changes, Kendall had pushed to reinvest the savings into back-to-work programmes, with the idea that getting more people into a job would bring down the benefits bill too. However, the Treasury favoured banking the savings.
To score its policies the OBR looks for evidence to back up its assessment. Paul Johnson, director of the Institute for Fiscal Studies, told the Times the watchdog would be more likely to score the Treasury approach.
King said its involvement in Treasury policymaking could help the chancellor with “objective, impartial and transparent” evidence.
However, objectivity in economics is permanently contested, while there are also dangers.
“When the OBR says the evidence for policies of this type clears the bar, and we will adjust the forecast for policies that look like this, it creates a huge incentive for the Treasury to go out looking for more policies that fall under that heading,” said King.
Led by Richard Hughes, a former researcher at the Resolution Foundation thinktank, the OBR has faced stiff criticism from politicians for its orthodox approach, and for verging into political territory.
As well as being sidelined by Truss for her mini-budget, Hughes drew further Tory complaints when he criticised Jeremy Hunt’s spending plans as a “work of fiction”. Many economists, however, say Hughes, whose five-year term expires in October, has done a good job, and expect him to be reappointed.
The bigger problem is not so much the OBR but challenging economic conditions, and the political difficulty in addressing them.
Gerard Lyons, chief economic strategist at Netwealth, said: “If when you have high debt, low growth and interest rates higher than they were before, then that naturally creates a very difficult outlook for the public finances.
“Spending is already high, and as we can see it’s a political challenge to get under control; taxes are already high, which doesn’t help the growth outlook, and borrowing is high, which makes the markets nervous if the government starts to borrow more.
“It’s the reality of where we are so you need to cut a path through this and have a credible way out.”
