Why fiscal rules matter: growth

Last week I discussed the importance of good fiscal rules for sustainability, but the recent mess in the UK has demonstrated how poor rules can inhibit growth. When the Government took office in 2010 it faced a startlingly high deficit. It promised to eliminate that within five years, which happens to be the length of a Parliament in the UK. That’s probably not a coincidence. As Portes and Wren-Lewis point out in their paper, Governments like operational targets that they can achieve within their term of office. If you face a big hole in your budget then promising to fix it within the decade is no good if you might only be in power for half that time.

That has important consequences for the way surpluses and deficits are dealt with. It means that governments tend not to save surpluses beyond their term because they reap little benefit from it. They also attempt to close deficits within the term, which can be too rapid when the deficit is large. The recent recession in the UK is a textbook example of the latter problem. Read more

Should the OBR cost Opposition proposals?

Today has seen a debate over whether the Office for Budget Responsibility should cost Opposition policies. Sajid Javid appeared on the BBC to defend the Government’s decision not to allow it. He avoided criticising the idea but pushed the Government’s line that now is not the right time to extend the OBR’s mandate. On the other side of the debate, Simon Wren-Lewis criticises the Government for delaying.

am a big fan of extending the OBR’s responsibilities but there are solid reasons for the Government to demur. Read more

Simon Wren-Lewis on the UK’s new fiscal rules

Simon blogs on the new fiscal rules and largely agrees with our view:

Getting the debt to GDP ratio to fall at some stage is a good idea, but having a target for a specific year is silly. It is not optimal because if some shock hits the economy before 2016/7 which means debt tends to rise relative to GDP, it is crazy to try and counteract that to meet the target in such a short space of time. It is not effective because it can be gamed by the government fiddling the timing of expenditures.

Having a five year rolling target for the deficit allows fiscal policy plenty of time to adjust to shocks. We saw this in action over the last few years, as the Chancellor was able to reduce the pace of fiscal consolidation from 2012 when the economy failed to recover as quickly as he had hoped. Changing this mandate from five to three years gives any Chancellor less time to adjust, which is why it is a backward step.

Why fiscal rules matter: sustainability

Before Christmas I wrote a couple of posts on fiscal rules and you might very well be asking why it really matters.

The first reason is that the current trajectory of public spending is unsustainable, but not in the sense that the Government means it. Sustainability in public spending should be measured over decades, not a single Parliament. The question is whether the current policy settings can be maintained indefinitely.

This is a chart of the UK’s debt-to-GDP over the past three centuries combined with the Office for Budget Responsibility’s latest long-run projections through to 2063-64. 1

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Notes:

  1. I have not used the OBR’s central projections here, which assume that health productivity more than doubles for the next fifty years. Instead, I have used the scenario that assumes productivity remains at historical levels.

The UK’s new fiscal rule won’t last

This post draws upon a blog I wrote for The Reformer.

A few days ago I wrote about the lessons that can be drawn from the recent history of the UK’s fiscal rules. This post measures the Government’s new Charter for Fiscal Responsibility against them. The Charter sets out the Government’s fiscal rule and requires the Office for Budget Responsibility (OBR) to assess Budgets against it. The new Charter lightly updates the previous version in two ways:

  1. It requires the Government to forecast a cyclically-adjusted, current account surplus within three years, rather than the previous five years.
  2. Public sector net debt should fall as a percentage of GDP in 2016-17, a year later than in the previous Charter.

Now compare against the lessons from history.
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A (very) short history of UK fiscal rules

Earlier this week the UK Government announced its new fiscal rule, which defines the fiscal envelope. For those of you who aren’t British, the deficit exceeded 10% of GDP during the recession and fiscal sustainability has become an important political issue, even for people who aren’t econ junkies! Unfortunately, this new rule is unlikely to encourage the sort of sustainability that the Government is hoping for. To understand why, I’m going to write a short series of posts on fiscal rules. This first post will briefly review the history of fiscal rules in the UK. For people who love technical details, this paper by Simon Wren-Lewis and Jonathan Portes is a great review and I’ll be coming back to it later.

A fiscal rule is simply a set of objectives that guide and constrain the Government as it makes policy. The rule usually comprises targets for debt and the deficit, with many variations in the details. Rules were introduced to the UK in 1997 by the then-Chancellor, Gordon Brown. Since then they have had a rocky history, as the chart shows:

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