MNI INTERVIEW: BOE Should Look More At Fiscal Risks-OBR Chief

The Bank of England should give more prominence to fiscal risks in its deliberations rather than take government spending and revenue plans at face value, Office for Budget Responsibility Chair Richard Hughes told MNI, pointing to a consistent record of under-performance in balancing official books.

"The risks in public finances are skewed to the downside and you see that in the pattern of debt over the post-war years, especially in recent years ... When governments have windfalls they tend to spend them but when they have shocks they don't adjust, they just accommodate them within the fiscal stance," Hughes said in an interview.

The OBR delivers a central projection alongside each budget, which is then incorporated into BOE projections and which takes government assumptions as givens, but Hughes said monetary and fiscal policymakers should pay more attention to the alternative scenarios, also produced by the OBR, which anticipate plausible risks to revenue and spending.

""We base our forecast on the government's policy of the day. Some of these risks are the result of wishful thinking on the part of governments. For example, we base our forecast on the government’s legislated policy that fuel duty will go up by RPI inflation, by it has been either frozen or cut in every Budget over the past decade," said Hughes.

“It is just as important for monetary policymakers to think about alternative scenarios as for fiscal policy. We do try and discuss ... our alternative scenarios with the Bank. The issue is getting people to take us seriously."

SPENDING OVERSHOOTS

Recent governments have tended to exceed the amount of spending initially promised in response to economic shocks, he noted, pointing as a case in point to the repeated extensions of the furlough scheme introduced in response to the Covid pandemic. By accepting government assumptions, the BOE therefore runs the risk of systematically under-estimating fiscal support or over-estimating tightening.

“The fiscal policy response to shocks is also getting bigger and these often pan out seemingly more frequently, more severely, and the fiscal policy response is bigger and that means all these downside shocks hit harder," Hughes said.

Speaking as several candidates vying to replace Boris Johnson as leader of the governing Conservative Party promise significant tax cuts, including proposals to reverse an increase in national insurance contributions or lower corporation tax, Hughes noted that the fiscal challenges facing the UK will be intensified by rising interest rates. (See MNI INSIGHT: BOE Multipliers Imply Rate Expectations Overblown)

"One thing that has actually been an upside windfall for government in recent years … has been interest rates, which had been falling in response to shocks and gave the government a bit more breathing room but has not been enough to make up for the massive cost of these shocks. That one is now reversing," Hughes said.

TAX CUTS

Tax cuts would do little to address the supply side hits of the Covid pandemic and the war in Ukraine which have driven higher prices, while any resulting boost to demand could prompt higher interest rates in future.

“Tax cuts can have a mild stimulative effect in the near-term ... but in the long-term the effect on economic activity is driven by the supply side of the economy … and the sort of things that work on the supply side take a very long time to work," he said. "We take a multiplier effect from tax cuts on the economy in the near-term but in the medium-term any excess demand is taken care of by monetary policy.”

In its fiscal risks and sustainability report, published Thursday, the OBR said that official support during the pandemic peaked at 10.4% of GDP and that another 1.25% of GDP has been allocated so far this year to help households cope with the cost of living shock. Key spending has been announced between budgets, it noted.