Commentators have always relied heavily on analysis by the Institute for Fiscal Studies (IFS) in the run-up to a Budget, or other “fiscal event”. The IFS’s own “Green Budget” is a regular fixture and widely read.
But this time it feels different. There is a risk that the IFS is seen less as an impartial referee and more as a politically-motivated attack dog. People should be aware of the limitations of what it can do and of what it says.
The IFS does serious work and is just as entitled to express a strong view as, for instance, the New Economics Foundation, or the Institute of Economic Affairs. That is not the issue.
It is also reasonable to argue that independent analysis of the public finances is even more important than usual, given the lack of detail to date from the new government itself, or from its official watchdog, the Office for Budget Responsibility (OBR). It would be wrong to shoot the messenger for flagging up any valid concerns.
Instead, the problem is something else. Or to be precise, two things.
The first is that the IFS is not really fit for the role it has taken on, or that others now attribute to it. The IFS describes itself as “the UK’s leading independent economics research institute”. Actually, I can think of several rivals for that crown, but we can let that pass.
However, the IFS’s expertise lies in the nitty-gritty of the public finances, especially the way in which each individual policy decision on tax and spending might affect individual households and businesses. In other words, it does ‘microeconomics’, and it does this well.
In contrast, the IFS has no special expertise in “macroeconomics”, or the big picture of economic growth, inflation, and the long-term prospects for overall public borrowing and debt.
This is not usually a particularly controversial point. Indeed, this is the main reason why the IFS collaborates with the US investment bank, Citi, on its “Green Budget”. It is therefore a US investment bank, not the IFS, which comes up with the forecasts for the UK economy on which the fiscal analysis is based.
But this disconnect is crucial, because it goes to the heart of the first problem. The IFS basically just tots up estimates for the direct costs of individual tax and spending measures, then lumps them in with macroeconomic projections from someone else, to arrive at a long-term path for overall borrowing and debt. This is, to borrow a phrase, just bean-counting.
The assumption about the profile for nominal GDP (or national income) is pivotal. The IFS, like many other commentators, often falls into the trap of focussing too much on headline numbers for annual borrowing, in cash terms. What really matters is the real burden of debt, expressed as a share of national income.
The cost of debt interest is a good example of this. Earlier this week we learned that UK government borrowing jumped in August, due largely to a debt interest bill of £8.2bn. But the biggest chunk of this is the uplift on the principal value of inflation index-linked gilts.
This will not actually be paid out until these bonds are redeemed, many years in the future, when the economic burden will be smaller. In the meantime, it is odd to worry that higher inflation might increase debt interest payments when real interest rates are still so low.
What’s more, the IFS (or Citi) makes little attempt to model the dynamic effects of tax cuts, or, even more crucially, the broader agenda of supply-side reforms that are at least as important a part of “Trussonomics”.
To be fair, this sort of dynamic modelling is difficult, but others do have a go. This includes the Taxpayers’ Alliance, the Centre for Economic and Business Research, and many other academic and private research organisations. At the very least, it is important to recognise the limitations of “abacus economics”.
This leads to the second problem, which is that the IFS goes too far in the claims that it makes. Every writer will point out that they are not always responsible for the headlines on their work, or how others chose to interpret the results.
However, the IFS’s Green Budget is being pushed as evidence that “reversing national insurance contributions and corporation tax rises would leave debt on an unsustainable path”. This is presented as a statement of fact, when it is just an opinion.
The detail of the “Green Budget” is a little more nuanced. The IFS does acknowledge, rather grudgingly, that “finding a way to somehow boost the UK’s rate of economic growth would undoubtedly help”. The IFS suggests that a boost to annual growth of 0.7 percentage points would be enough to stabilise the ratio of debt to national income.
But this is actually rather less than the government is aiming for. And the IFS is wrong to imply that this is based on a sustained boost to growth from tax cuts alone.
What about the line that the IFS has had to step in because of the lack of new forecasts from the OBR? The government has taken the view – not unreasonably – that it is not necessary to produce a full forecast before starting to implement the economic programme on which the new Prime Minister has just been elected. What would this add?
It makes more sense for the OBR to wait until later in the year, when it has more information on the economic impact of the Energy Price Guarantee and other policy measures, as well as movements in financial and commodity markets.
Interestingly, the minutes of this week’s meeting of the Bank of England’s Monetary Committee suggested that some members also wanted to see what impact these measures would have on demand and inflation, before signing off a bigger increase in interest rates.
In short, the government is only just beginning to solve the UK’s longstanding productivity puzzle. Taking a bolder approach is surely less of a “gamble” than persisting with the existing orthodoxy, which has already failed.
Julian Jessop is an independent economist. He tweets @julianhjessop.