Friday, September 23, 2011

Zeno’s paradox of fiscal policy and Osborne’s prophet motive

As Duncan reminds us, the central aim – the “fiscal mandate” – of the government’s fiscal policy is this, as set out by George Osborne in last June’s Budget:

the structural current deficit should be in balance in the final year of the five-year forecast period, which is 2015-16 in this Budget.

The thing about the fiscal mandate is that it’s a rolling target. In June 2010, the end of “the five-year forecast period” was 2015/16. Now it’s 2016/17. During the next election campaign, it’ll be 2020/21.

(Also note that it covers cyclically adjusted borrowing, excluding capital spending. These caveats take out a hefty chunk of the actual deficit. And yes, Brown was just as bad, with his ‘borrow only to invest over the course of the economic cycle’ Golden Rule.)

Which means that the notion of ‘hitting’ this particular target collapses – like the protagonists in Zeno’s paradoxes of motion, we’ll never reach the end of the rolling five-year period and see where it hits. But if Osborne can’t ever hit (or miss) the target, all we can do is judge whether he’s ‘on course’ to hit it.

This is why the Office for Budget Responsibility is so important to him: the official central objective of fiscal policy is for the announcement of that policy to induce the OBR to make a favourable forecast. That’s all.

It is, of course, ridiculous to think that government borrowing can be accurately predicted that far ahead. Osborne and the rest, whatever their faults, are (mostly) not mentally subnormal. And the OBR shows no signs of being any more accurate a coven of seers than the in-house Treasury forecasters used to be.

All of which means that the fiscal mandate in itself is a convenient fiction. Nobody cares about a few billion pounds here or there several years down the line. The real aim of this device is to persuade the king’s prophets to pull something out of the entrails that will give the troops confidence for the fight. And, given the sheer amount of ‘eliminate the deficit by the end of this parliament’ coverage that’s followed, it’s working. Politically, at least. Temporarily, at least.

Because Osborne has allowed an impression to take hold that the target is more rigorous than it really is. That suits him for the time being. But those simplified headlines, which he’s hardly rushed to correct, may end up as embarrassing for him as “Brits 45 mins from DOOM” became for Blair. In early 2015, when we’re still borrowing however much, it’ll look like a failure.

(And, as Duncan also points out, there’s also a ‘supplementary’ target that does have a fixed date: for government debt as a share of GDP to be falling by 2015/16.)

Updte: here's a chart showing what happens to the deficit when you adjust for the economic cycle and then take out capital spending (predictions as per Budget 2011):

Note that Osborne's taget measure (the green line) excludes roughly half of public borrowing at the moment. This cyclically adjusted current deficit was hardly out of control before the credit crunch hit; indeed, Labour had it lower going into their recession than the Tories had it going into theirs at the start of the 1990s. I raise this not to imply that everything was fine in 2007 but to point out that Osborne's choice of target doesn't necessarily do the political work he'd like it to.

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