Fiscal Policy under Labour

By Budd, Alan | National Institute Economic Review, April 2010 | Go to article overview
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Fiscal Policy under Labour


Budd, Alan, National Institute Economic Review


The incoming Labour Government of 1997 promised a new approach to the conduct of fiscal policy. Two lessons to be learnt from previous experience were: (I) adjust for the cycle and build in a margin for uncertainty; (2) set stable fiscal rules and explain clearly fiscal policy. Although the claims for novelty were exaggerated there was a serious attempt to expand the supporting explanatory material at the time of the Budget and the Pre-Budget Report (which was itself an innovation). It started well, with the most significant tightening of fiscal policy occurring in 1997-8; but it ended with a record postwar deficit, a debt/GDP ratio heading for more than 75 per cent of GDP and the suspension of the fiscal rules. While the Treasury was not alone in failing to forecast the financial crisis and its consequences, doubts about the policy were being raised before 2007. Although the fiscal rules were met over the preceding period and projected to be met in future, a succession of current budget deficits and a tendency, from 2001 onwards, for over-optimism in fiscal projections left the UK less well equipped than it might have been to meet the challenges of the crisis.

Keywords: Fiscal policy; budget deficit; public finances

This survey examines the macroeconomic aspects of fiscal policy since 1997. The first section describes the Labour Government's approach to fiscal policy. The second describes the fiscal actions during the successive parliaments. The final section presents an appraisal.

I. The policy framework

Nobody can accuse the Labour administration of being reticent about its approach to fiscal policy. The amount of documentation that accompanied each Budget and Pre-Budget Report (PBR) was enormous and the Treasury also published a substantial book about it (Balls and O'Donnell, 2002).

A newly victorious administration, following a change of ruling party, has to decide, over a wide range of policies, whether to emphasise continuity or change. The new Conservative Government of 1979 had, in a fairly extreme way, chosen to emphasise change. Its economic policies produced, among other things, a break in the economic consensus, signified in the letter from 364 economists following the Budget of 198 l. But as policies developed in successive parliaments, it was possible to detect a new consensus. Its main elements were:

* A recognition that there was no long-term trade-off between inflation and unemployment.

A move from intermediate to final targets in policies to control inflation. Explicit inflation-targeting, albeit in the form of a range, was introduced in October 1992.

A shift away from the use of discretionary fiscal policy towards interest rates as a way of influencing aggregate demand (while allowing the automatic stabilisers to operate).

* An emphasis on longer-term objectives, relating to sustainability, in the setting of fiscal policy.

A preference for the use of market instruments rather than directives or controls in seeking to affect the pattern of consumption or production.

It is the third and fourth of those elements that particularly concern us here. It might be thought that inter-party agreement on the conduct of macroeconomic policy was a desirable element in providing a stable environment in which households and firms made long-term decisions (though, of course, correctness is more important than continuity). However the incoming Labour Government chose to emphasise change and made considerable use of the advertisers" favourite word 'new'. How accurate this was is a matter for debate; but presumably it was a political choice.

"The Queen's College, Oxford. e-mail: alan.budd@queens.ox.ac.uk.

The new approach to policy

Descriptions of the Labour Government's approach to fiscal policy were provided in a number of sources in the period leading up to and following the General Election.

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