Do Budgets really matter?
All eyes will be on George Osborne’s Budget today. An immense amount of media attention and serious commentary will be devoted to it. But do Budgets really matter? How much difference would it make if successive chancellors simply did nothing, apart from indexing various allowances and benefits in line with inflation?
From time immemorial, British governments of all shapes and sizes have had to present their finances to Parliament for approval. For centuries, there was a constant struggle between the monarch, who almost invariably wanted more money to pay for the court or foreign wars, and the elected representatives, who were usually unwilling to vote for the taxes such policies required.
After the Second World War, however, the annual ritual of the Budget took on a completely different character. Armed with what were then seen as the insights of Keynesianism, successive chancellors regarded the Budget as a means of announcing policies which would control the economy in the forthcoming year. Even now, Osborne will spend time discussing the short-term predictions for UK GDP growth, inflation and the like. These are now produced by the Office for Budget Responsibility rather than by the Treasury itself, but they still form an important part of the Budget speech.
To be able to make meaningful interventions in the economy and bring about better outcomes over the short term, it is absolutely necessary to have reasonably accurate forecasts. Unless you have a good idea of where the economy is going to be this time next year, you have no clue about what actions to take now to get it into a better place.
It is well-known, however, that economic forecasts are – to put it charitably – poor. Even in the United States, where the economy is more insulated from unexpected external shocks, the record is pretty shocking. The Philadelphia Fed publishes the consensus forecasts made by economists for a range of variables. For GDP growth one year ahead, the forecasts, looking over several decades, are actually on average correct. But this conceals large errors in many years – it is just that, over time, the errors are cancelled out. And the forecasts are particularly bad at capturing tipping points, when there is about to be a boom or a slump.
This was the question the Queen put to the faculty at the LSE. Why had they not foreseen the crisis? To be fair, economic forecasting is a very hard scientific problem, which does not readily admit a solution.
So while the forecasts themselves are questionable, Budgets nevertheless remain important because of the narrative which the chancellor tries to portray about the economy. Nigel Lawson’s Budget of 1988 is rightfully famous. Not because it failed to predict the looming crisis in 1990, but because it set the tone in which enterprise was celebrated, thereby laying the foundations for the long boom of the 1990s. Osborne in 2010 seized the imagination of the markets and persuaded them that the public finances were sound. It is the narrative about the medium and longer term which matters, not the illusion of short-term control.
As published in City AM