Even before the double win in last week’s by-elections, Labour was behaving like a government-in-waiting. Apparently the party has begun drafting the bills for the initial pieces of legislation it will enact after the election.
When George Osborne was at the Treasury, the Conservatives created the Office for Budget Responsibility (OBR). This meant responsibility for the economic forecasts contained in Autumn Statements and Budgets was handed over from the Treasury.
Rachel Reeves has proposed to take this further, creating a more rigorous “fiscal lock”. Any major changes to public spending or taxation will have to be screened by the OBR’s economic model and the results put into the public domain. In effect, the Shadow Chancellor would give the OBR a decisive voice in economic policy.
The move is analogous to the one made by Gordon Brown in 1997 when he made the Bank of England independent and created the Monetary Policy Committee. The membership of the MPC would be decided by the Treasury, but the MPC itself would operate completely independently.
To be fair to Brown, in the first few years he did appoint people who both held independent views, and who were willing to disagree with other members. Gradually, however, groupthink took over and dissent was eradicated. All members now subscribe to the conventional wisdom which has dominated academic economics for over two decades.
Prior to the financial crash of the late 2000s, the prevailing orthodoxy was that we are now in a benign “Great Moderation”. The main policy problems of macroeconomics had finally been understood.
Indeed, Olivier Blanchard, a former chief economist at the International Monetary Fund, published a working paper for the prestigious National Bureau of Economic Research which concluded, overall, that “the state of macro is good”. Three weeks later, Lehmann Brothers collapsed.
Even this did not shake the groupthink. We have seen the same thing occurring over inflation. The MPC not only failed to see the rise in inflation but persisted in claiming that the increase was purely temporary.
This time the Bank have recognised that there might be a problem and have commissioned a review of the MPC’s models and forecasts.
The effective delegation of powers to the OBR runs the risk of history repeating itself. It cannot be stressed too strongly that our understanding of how the macroeconomy works and the impact of policy changes on it is highly imperfect. Different models both can and do give completely different answers.
Take, for example, the basic but fundamental question of the eventual impact of a sustained increase (or reduction) in public spending. Mainstream models themselves give different results. A major survey of American models just over a decade ago showed that a sustained increase of $1bn in public spending would increase the size of the overall economy by as much as $1.5bn, but it could be as low as $0.8bn – lower than the size of the boost itself.
Outside the mainstream, an important school of thought led by Robert Barro and Alberto Alesina at Harvard contends that fiscal expansion can actually shrink the economy.
If the OBR is given these new powers, it is imperative that the trap of groupthink is avoided, and a wide range of models are used in evaluating fiscal policy changes.
