A plea to the next Chancellor

Published on antibuerokratieteam.de (Blog), 15 April 2007

Now that Gordon Brown has delivered his 11th and final budget, it is time to ask what general lessons can be drawn from his Chancellorship. We believe that in retrospect Mr Brown has made two strategic decisions that will be the lasting legacy of his tenure at 11 Downing Street. The first and foremost of these was to give independence to the Bank of England by establishing its Monetary Policy Committee (MPC). Although controversial at the time, this has been a major contributory factor towards creating the monetary and economic stability that the UK has experienced in recent years. The second of Brown’s lasting contributions as Chancellor of the Exchequer was the introduction of fiscal rules by which he was going to make his policies more predictable and stable. Unfortunately, these rules were better in theory than in practice with the Chancellor and the Treasury diminishing their effectiveness by either changing the rules, or at least interpreting them in a creative way.

Why is it that the Bank of England’s independence worked so well while the Treasury’s fiscal rules did not lead to greater fiscal discipline? The reason is simple: Whereas the MPC operated outside government, making independent decisions to meet a pre-set target for the inflation rate, the Treasury was in charge of setting its own targets, forecasting its figures and assessing its own performance.

We, therefore, believe that any future Chancellor should learn from Mr Brown’s experience and begin his stewardship of the economy with a step that matches Gordon Brown’s courage in giving independence to the Bank of England. This is why we suggest sourcing out both the stewardship of the fiscal rules and the Treasury’s economic forecasting activities to an independent Fiscal Policy Committee (FPC), to be modelled on the MPC. In fact, we think that this is the first policy decision that Gordon Brown’s successor should make.

Why should the next Chancellor give away such flexibility? The answer is the same as for the Bank of England: it will take much of the politics out of the process. At the moment the Treasury both makes the policy decisions and the forecasts that underpin them. We think this is not the right solution. It is too convenient for the Chancellor and the Treasury to tweak the forecasts or assumptions to ensure the fiscal rules are met. The Treasury has always denied such gerrymandering but it is remarkable how often changes in assumptions mean the rules are met. Indeed, despite its unique access to data and resources, the Treasury’s record of forecasting economic figures is little better than average. This is not just a UK phenomenon. Finance ministries worldwide tend to be too optimistic in their forecasts of growth and deficits.

Our proposed solution of an independent FPC would allow for a truly independent assessment of the government’s fiscal policy and the macroeconomic environment in which fiscal decisions are made. It would be responsible for writing the pre-Budget report in which economic forecasts would be made over the usual budget horizon with estimates made of the likely profile of both the budget deficit and national debt on the basis of existing spending plans and tax rules. These would be compared against the government’s rules and an estimate made of the likely change in taxation/spending needed at the Budget to meet the rules. The FPC would then provide a Budget Assessment report within four weeks after the publication of the Budget, making a judgement on whether the measures proposed would be sufficient to meet the rules.

What would the government and Treasury’s role be in this system? At the start of each Parliament they would be required to set out the fiscal rules against which they would be judged. The decisions over the structure of the tax system, the proportion of GDP taken by the public sector and individual tax decisions, which they commend to Parliament, would of course remain the property of the Chancellor and his Treasury. They would, however, need to justify their fiscal positions against the reports from the FPC.

The FPC has to be independent from the political process. Otherwise it will be lacking the authority to challenge the government or to provide credible expert advice to Parliament, the public and, of course, the Chancellor. We suggest that the FPC should be created by an Act of Parliament in which economic and legal qualifications for its members are to be clearly defined. A chairman and two deputies should be appointed for periods of seven years with one possible extension, with staggered tenures, while they would be assisted by a further three members of the committee for a period of five years, also with one possible extension. The FPC appointments should be made on the suggestion of the Chancellor, but candidates would have to be vetted and approved by the Economics Select Committee of the Upper Chamber of Parliament. This would ensure that the FPC would be an institution detached from day-to-day politics and could thus develop a reputation for genuine independence over time. It may also be desirable, albeit not necessary, that there will be an exchange of experts between the MPC and the FPC.

We believe a better fiscal policy is possible if government’s adherence to its own fiscal rules were independently monitored and assessed. What the MPC has achieved in monetary policy could also be done in fiscal policy by a new independent fiscal watchdog. We, therefore, argue that the first task of a new Chancellor should be to create such an FPC. Future Chancellors should provide the yardsticks by which they want to be measured, whether it is public spending as a percentage of GDP, borrowing, or other key figures. But the measuring and forecasting should be done by someone else, and independent advice should accompany all of the government’s policies which carry fiscal consequences.

We trust that the next Chancellor will be as imaginative and bold as Gordon Brown was in his first term in office. The best way to demonstrate this, in our view, would be the creation of such a Fiscal Policy Committee.

James Barty is Head of Strategy at an Investment Bank Hedge Fund
Dr Oliver Marc Hartwich is Research Director for Economic Competitiveness at Policy Exchange
Dr Holger Schmieding is Head of European Economics at Bank of America
PS: The idea was reported in the Sunday Telegraph (London) on 15 April 2007:

What’s the betting they’ll trample on it?

By Robert Watts

Every so often an idea comes along that sounds so compelling that one hopes it becomes reality before the naysayers and sceptics have time to draw breath – let alone throttle it with tedious counter-arguments.

One such idea landed in my inbox last week.

A leading hedge fund manager, a City economist and the right-of-centre think-tank Policy Exchange proposed the creation of an independent panel as guardians of the way the Government runs the economy and uses – or should that be abuses? – our tax system.

If such a move sounds far-fetched, cast your mind back to before 1997, when it seemed the idea of prising our politicians’ hands off our interest rates seemed equally fantastical.

The brains behind the new plan don’t lack chutzpah. They say it would create much greater transparency over how the Government spends our cash and stop politicians slipping through more of those sneaky stealth taxes we’ve grown accustomed to over the past decade.

The nine-strong panel would be made up of economists, accountants, academics and lawyers, and take the name Fiscal Policy Committee – an allusion to the Monetary Policy Committee, on which the FPC would be based.

At monthly meetings, the new panel would assess whether government spending and borrowing are running to plan. It would compile the Pre-Budget Report and publish a thorough audit of the Budget each year. And the panel would also compile all the contentious growth forecasts for the economy, which are currently cooked up by number crunchers at the Treasury under the eye of the Chancellor.

That effectively allows the Chancellor to be chief witness, jury and judge when assessing Britain’s economic performance and, crucially, whether his fiscal rules have actually been met.

For those of us who have grown accustomed to overblown growth forecasts, never-ending economic cycles and an ever more complicated tax system, this all sounds highly attractive. As does the idea of having a new independent organisation to examine the Chancellor’s policies.

Some of the groups that are supposed to keep an eye on the Chancellor’s handiwork have started to look more like lapdogs than watchdogs recently.

The Treasury Select Committee used to do what it’s meant to – examine Treasury policy. Some of the committee’s latest investigations have focused on the intricacies of travel insurance, private equity and cash machines.

Not so long ago business groups such as the CBI and the Institute of Directors didn’t just scrutinise Treasury policy – they would criticise it. Now such organisations speak all doe-eyed of “engaging” with Downing Street, rather than speaking out.

As yet the Fiscal Policy Committee may only be a think-tank’s fantasy, but the biggest obstacle to its creation would be finding a Chancellor brave enough to take the criticism.

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