Fiscal risk analysis at the OBR Robert Chote Chairman 6th Annual meeting of OECD PBOs and IFIs Jerusalem, 1 April 2014 Context: role of the OBR • “examine and report on the sustainability of the public finances” • Four main tasks: – – – – Produce five-year forecasts for economy and public finances Judge progress towards government’s targets Scrutinise costing of tax and welfare policy measures Assess long-term sustainability of public finances Levels of fiscal risk • Risk of deviation from forecast • Risk of missing stated targets • Risk of long-term unsustainability – And eventual need for some policy change • Risk of crisis – And sudden need for big policy change Medium term forecast/targets • Required to assume unchanged policy – Ignore political risk but not delivery risk: fuzzy line • And to judge if government has a ‘better than 50%’ chance of meeting targets • Implies pass/fail test on median forecast • But important to recognise uncertainty Sources of fiscal forecast deviation • Economic determinant forecast errors • Fiscal forecasting (‘technical’) errors – E.g. yield from tax disclosure agreements – E.g. forestalling of pre-announced tax rate changes – E.g. local authorities’ spending behaviour • Policy changes • Classification changes – E.g. change to net debt definition Explaining forecast errors ex post Illustrating forecast/target uncertainty • Past forecast errors • Sensitivity to key economic determinants • Scenario analysis Probabilities based on past errors Cyclically-adjusted current budget balance Past errors imply c.75% chance of achieving target of structural current budget balance five years ahead Mechanical sensitivity analysis • Bigger/smaller output gap • Faster/slower GDP growth • Higher/lower government borrowing costs • Higher/lower cyclical adjustment coefficients Selected scenario analysis • Used to highlight key debates/critiques • March 2014: what if interest rates rise faster? – Response to faster recovery (‘good’) – Response to rise in risk premia (‘bad’) • Past examples – Spike in oil prices – Euro-zone crisis (took OECD scenario) More focus on economic risks? • Easier to summarise in sensitivity and scenario analysis – and in forecast narrative • In March 2014 we highlighted as risks: – – – – – Volatility from tighter global monetary policy Danger of renewed euro-zone instability Escalation of tension in Russia/Ukraine Productivity growth failing to recover Growing household borrowing and indebtedness • Fiscal forecasting risks more specific – Some tax bases hard to forecast/proxy • e.g. income and house price distribution – Behaviourial/administrative uncertainty • e.g. trends in miles driven or disability assessments – Also look at contingent liabilities from WGA Quantifiable contingent liabilities • WGA only available with a lag, so also note new liabilities • In June 2013 highlighted greater use of guarantees – Probably ‘remote contingent liabilities’ but also correlated if economy tanks Unquantifiable contingent liabilities Long-term uncertainty/risks • Central projection based on ‘unchanged’ policy • Calculate debt trajectory and fiscal gaps • Sensitivity analysis – – – – – Fiscal position at end of medium-term forecast Long-term relationship between interest rate and growth rate Demography: ageing / net migration flows Productivity Health spending • Also issues in tax revenue sustainability – – – – North Sea oil receipts Motoring taxes Globalisation and corporation taxes Retirement behaviour Risks in policy costings • Key judgements in policy costings set out with each Budget / Autumn Statement • OBR annex highlights key uncertainties, usually around behaviour or identifying tax base • Anti-avoidance measures often popular and particularly uncertain in their effect – Expected attrition taken into account explicitly • Sometime policy costings not certified/included because details, timing or approval not certain – E.g. assets sales where time/price not known – Required to identify these as risks