Chancellors' Asymmetric Responses To Good And Bad News Since 2010 Resulted In More Debt And A Bigger State

28th September 2023

Since 2010, Chancellors have not responded symmetrically to good and bad economic news.

Since 2010, when the Office for Budget Responsibility (OBR) has presented the government with a windfall - i.e. improved public finance forecasts - successive Chancellors have tended to spend the majority of it, mainly by topping up their spending plans. But when public finance forecasts have got worse, Chancellors have tended to accept higher borrowing, rather than announce offsetting tax rises or spending cuts. The result was tens, if not hundreds, of billions of additional borrowing over the 2010s, and a bigger state than originally planned.

Given the inevitability of future shocks and revisions to forecasts, continued behaviour of this sort will lead to a continuing upward ratchet in spending, borrowing and debt. It also means that official ‘central' forecasts cannot really be thought of as central. Irrespective of anything else, if future Chancellors continue to behave like their predecessors, and shocks come along like they did during the 2010s, then we estimate that an appropriate central forecast for borrowing in 2027-28 would be 3.1% of GDP, rather than 1.7% under the OBR's forecast - around £40 billion higher. Our simulations, based on Chancellors' decisions since 2010, suggest that there is a nine-in-ten chance that borrowing turns out higher than the OBR forecast.

These are among the findings of new research from the Institute for Fiscal Studies, published today as a pre-released chapter of the 2023 IFS Green Budget, produced in association with Citi and with funding from the Nuffield Foundation. Other findings include:

Since 2010, Chancellors have not responded symmetrically to good and bad economic news. They tend to spend a bigger fraction of improvements in the public finances (by reducing taxes and/or increasing spending) than they offset (through tax rises and/or spending cuts) when the public finance outlook deteriorates. Chancellors have, on average, spent 60% of a medium-term public finance improvement, and offset just 27% of a deterioration.
The result was tens, and possibly hundreds, of billions of additional government borrowing over the 2010s. Public sector net debt at the eve of the pandemic could have been between 3% and 11% of GDP lower – with a central estimate of 7% – had Chancellors responded symmetrically to underlying forecast changes over the preceding decade.
This is not to suggest that borrowing should have been lower over the 2010s. But whatever the starting point – i.e. even if the post-2010 government had set out to run looser fiscal policy from the outset – the tendency to respond asymmetrically to good and bad economic news would have led to a ‘ratchet effect' that left borrowing tens or even hundreds of billions higher than original plans implied.
When economic conditions improve, Chancellors since 2010 have tended to top up their spending plans, rather than use any ‘windfall’ to cut taxes. When conditions worsen, they have tended to cut back their spending plans and raise taxes. Combined, this tendency has acted to increase the size of the state over time.
In 100,000 simulations of future shocks and subsequent policy responses, we estimate that there is just a one-in-ten chance that borrowing in 2027–28 turns out lower than the OBR forecast. This is symptomatic of a wider issue facing the OBR: the requirement to take government policy as stated, rather than exercise its judgement about the most likely path for policy, can make it more likely that its forecast underestimates borrowing.
Isabel Stockton, Senior Research Economist at IFS and a co-author of the research, said:

‘Past experience suggests that Chancellors don’t respond symmetrically to economic shocks. This represents a non-trivial risk to the accuracy of official borrowing forecasts, and potentially to fiscal sustainability.

‘If Chancellors cannot credibly commit to behaving more symmetrically, then one option to limit the impact of their asymmetric behaviour would be to provide them with fewer opportunities to adjust policy, by having just one fiscal event per year. That would provide fewer opportunities for headline-grabbing policy measures, and would probably improve the quality of fiscal policymaking more generally.’

Key findings
Forecasts for government borrowing are uncertain and subject to frequent revision. Over the last four decades, borrowing has turned out higher than the median forecast for that year on three-quarters of occasions. In other words, forecasts have tended to underestimate the future level of borrowing. This was particularly the case just prior to periods of economic distress, such as the early 1990s, late 2000s and the pandemic, but is true generally.

Forecast revisions often reflect economic ‘news’ since the previous forecast and unfortunately, since 2010, there has been more bad news than good. Across the 26 fiscal events since 2010, there have been just 8 occasions on which economic news has meaningfully improved the borrowing outlook, versus 12 where bad news has materially worsened the outlook. On 6 occasions, there was no meaningful change.

Chancellors often adjust their tax and spending plans in response to these forecast changes. For example, if the economic and fiscal outlook improves, it could be that the Chancellor is able to lower taxes and/or increase spending and still be on track to meet his or her stated objectives for borrowing or debt. Conversely, if the outlook deteriorates, the Chancellor might decide to raise taxes and/or cut spending to return forecast borrowing back towards the desired level.

It matters whether or not Chancellors respond symmetrically to good and bad news. If Chancellors respond asymmetrically to underlying changes in borrowing forecasts – for example, by spending windfall gains in the case of good news, but accommodating increased borrowing when bad news comes along – then over time, borrowing will systematically diverge from that forecast. This represents a non-trivial risk to the accuracy of borrowing forecasts, and potentially to fiscal sustainability.
Chancellors have not responded symmetrically to good and bad economic news since 2010. On the 12 occasions when economic conditions deteriorated meaningfully between fiscal events, Chancellors have planned to offset just over a quarter (27%) of the medium-term borrowing increase, on average, by reducing the planned level of spending and/or announcing tax rises for implementation by the final year of the forecast period. Meanwhile, when economic conditions improved, Chancellors have planned to offset an average of 60% of the windfall through higher spending and/or lower taxes.

This tendency for Chancellors to loosen more than they tighten in response to economic news led to tens, and possibly hundreds, of billions of additional borrowing over the 2010s. Public sector net debt at the eve of the pandemic could have been between 3% and 11% of GDP lower – with a central estimate of 7% – had Chancellors responded symmetrically to underlying forecast changes over the preceding decade.

Asymmetric policy responses mean that the Office for Budget Responsibility (OBR)’s central forecast is not actually ‘central’. Based on Chancellors’ past responses to shocks, and assuming good shocks are as likely to come along as bad ones, we estimate that forecastgovernment borrowing in 2027–28 should be 1.4% of GDP higher than under the OBR’s central forecast. In 100,000 simulations of future shocks and subsequent policy responses, we estimate that there is just a one-in-ten chance that borrowing turns out lower than the OBR forecast. This is symptomatic of a wider issue facing the OBR: the requirement to take government policy as stated, rather than exercise its judgement based on past government behaviour, can make it more likely that the forecast underestimates borrowing.

When economic conditions improve, Chancellors since 2010 have tended to top up their spending plans, rather than use any ‘windfall’ to cut taxes. When conditions worsen, they have tended to cut back their spending plans and raise taxes. Combined, this tendency has acted to increase the size of the state over time. We estimate that if future Chancellors respond to economic news in the same way as their predecessors, the forecast for total government spending should be 1.6% of GDP higher in 2027–28 than under the OBR’s central forecast. In contrast, forecast government revenues would be just 0.2% of GDP higher in our simulations.

In the short term, Chancellors tend to announce a policy loosening (i.e. higher spending and/or lower taxes) regardless of whether there has been an underlying economic improvement or deterioration. This may be appropriate – depending on the nature of the economic news – but risks a further ‘ratcheting’ effect if short-term loosenings are implemented but medium-term tightenings are ever-postponed.

Read the detailed report HERE