There are many lessons for Labour’s bruised leadership from last week’s embarrassing U-turn on welfare cuts, but one is surely that how – and when – fiscal policy is set is not working.
Binary fiscal rules, a slim margin for error (less than £10bn), and the Office for Budget Responsibility’s twice-yearly forecasts, have combined to turn tax and spending decisions into a grim spectator sport.
City analysts are constantly second-guessing exactly how Rachel Reeves’s hand will be forced next. As the Bank of England governor, Andrew Bailey, put it last week, before the benefits climbdown, “having the financial markets marking fiscal policy to market on a daily basis is not a good state of affairs”.
The chancellor promised to hold only one budget a year, at which tax changes would be announced: a decision aimed at demonstrating stability and strength.
However, the Treasury began signalling during the bond market panic in January that she was prepared to use her spring statement to make spending cuts, if higher interest costs set her on course to break her fiscal rules.
Some wise heads argued at the time against the idea of hastily drawing up cuts, tailored to close whatever gap the OBR identified in five years’ time – the period over which the rules are assessed.
As the former Bank deputy governor Charlie Bean put it: “I think we want to get away from this idea that we continually have to be neurotically changing taxes and spending to try to control this OBR forecast so that it’s hitting our target.” In his understated way, Bailey effectively agreed with that this week, arguing: “There is a danger in overinterpreting a five-year-ahead forecast.”
They are right: one result is hasty policy changes driven by cost-cutting targets (although the Treasury lays part of the blame on the Department for Work and Pensions for, it claims, dragging its heels over the reform package).
Another consequence is that the debate over economic policy ends up being reduced to a desiccated row over tax and spend.
That is especially depressing, given that the contours of an economic strategy are starting to emerge more clearly, a year into Labour’s term.
The focus last week was meant to be the “modern industrial strategy” – a hefty document that set out a new approach to nurturing eight strategic sectors, including clean tech, advanced manufacturing and the creative industries.
There was much to praise – a senior figure at one business lobby group joked that they would struggle to know what to campaign on next, as so many of their long-running asks had been met.
Unions were gratified at the focus on creating jobs and funding additional training – and the promise of workforce strategies for sectors experiencing skills shortages.
The government’s pragmatic trade strategy, also published last week, was another victim of the overwhelming focus on the welfare row.
All this was lost in the Westminster drama of defending the cobbled-together cuts and then negotiating the concessions that already looked inevitable when Reeves insisted on Monday that there would be “no U-turn”.
Her team now have two unenviable tasks ahead of them. First, they will have to start work on a possible package of tax increases to announce in the autumn.
As her aides are keen to point out, she could yet strike lucky: growth could bounce back; inflation could ease more rapidly than expected, freeing the Bank of England to crack on with rate cuts; and gilt yields could slide.
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Treasury officials will be pushing hard over the summer to try to convince the OBR to take into account the growth-friendly nature of some of the government’s policies, perhaps nudging forecasts in the right direction.
However, the majority of independent experts currently believe it is more likely than not that the OBR will downgrade its expectations of productivity – and therefore growth – setting Reeves on course to breach her fiscal rules, even without the £4bn-plus cost of the policy swerves on winter fuel and disability benefits.
Reeves could ditch those fiscal rules, of course – but that would be sticking two fingers up at flighty financial markets.
Tweaking the rules to allow herself more leeway seems less unthinkable, given how many times previous chancellors rewrote their own rules – but she would have to proceed with caution.
While they deny that they are poring over a menu of potential tax rises (although they surely must be), Reeves’s allies privately concede that they are thinking about how to avoid another debilitating annual cycle of fevered speculation about fiscal policy.
Here they have a number of options, some of which were set out by the International Monetary Fund in its recent report on the UK economy.
One is just to build up a bigger buffer against the fiscal forecasts, of course, to reduce the constant sense of jeopardy – but that would probably require an even bigger tax grab.
Another would be to commission only one OBR forecast a year instead of two – dodging the spring iteration that prompted the scramble for welfare cuts.
This possibility alarms the Treasury, with its echoes of Liz Truss, who saw the OBR as part of the “anti-growth coalition” and paid the price in the bond markets.
A sensible halfway house might be to continue to commission two forecasts but treat the spring one – given there is no budget alongside it – simply as a useful waymarker, for what the chancellor might have to consider in the autumn.
Whatever emerges from this rethink, it must allow Reeves to be more flexible in the face of changing economic circumstances because the framework she so carefully constructed to project strength has instead trapped Labour into decisions that ultimately proved untenable.