Fiscal rules need an enforcer

Since the Autumn Statement there has been a lot of discussion about fiscal rules. One of the most substantive comments has come from Simon Wren-Lewis, who is something of an expert on the subject of fiscal rules and fiscal councils. His conclusion is that

…the main problem with the UK government’s fiscal mandate has nothing to do with cyclical adjustment or any of the other things discussed above. It is just inappropriate for the situation we are now in.

There is a lot of good stuff there, so head over and read it, but I’m not convinced by this conclusion. To understand why, let’s go back to the reason for a fiscal rule. The idea is that we need rules to commit the Government to a sustainable debt path because the political incentives don’t necessarily push them in that direction. That means the rules need to constrain the government’s actions in times when it is inconvenient for them to exercise prudence. It is certainly not enough for the rules to be kept only when it is politically convenient.

Wren-Lewis is saying that there will be times when even the best rules must be broken. However, if the Government is given the task of deciding when to break the rules then they may as well be discarded. Rules that bind the Government only when it feels like being bound will never do the job that they were designed for. To be effective, fiscal rules must be resilient to external shocks so that they can force governments to do the prudent thing when it not in their political interests to do so. Anything else compromises the credibility of the rules beyond saving.

That is not to say I disagree with Wren-Lewis that there are circumstances in which you might want to breach the rules, whatever they are. It’s just that you can’t let the Government decide when such circumstances have arisen. This is a strong argument for having an independent body to enforce the fiscal rules, and to decide on circumstances in which they might be legitimately ‘bent’. Rules are usually used in tandem with an independent council who can both enforce the rules and credibly legitimise departures from them. In Sweden, for example, the independent fiscal council recommended that the government run bigger deficits during the financial crisis.

Wren-Lewis may be right that the UK’s current rules are too inflexible to deal with the present situation, but a government can’t expect to break its own rules and retain credibility. Either another mechanism must be found or the fiscal rules become a paper tiger.

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