Magazine article Public Finance

A Sustainable Fiscal Rule?

Magazine article Public Finance

A Sustainable Fiscal Rule?

Article excerpt

In 1997, Gordon Brown, then chancellor, announced that the Labour government would adhere to two fiscal rules - the golden rule and the sustainable investment rule. These were designed to signal that New Labour would manage the country's finances better than the preceding government.

Eleven years on, there are now hints that the sustainable investment rule will be revised. But if a new rule allowing additional borrowing were introduced just as the current rule would have been breached, would the credibility gained from having fiscal rules be undermined?

The sustainable investment rule requires the government to keep the public sector's debt at a 'stable and prudent' level. In the 2003 Budget, Brown stated that in practice this would mean that net debt will be maintained below 40% of gross domestic product in each and every year of the current economic cycle. There was nothing special about the choice of 40%, but compliance would ensure that debt was kept below the level bequeathed by the previous Conservative government.

The latest forecasts for debt published by the Treasury in its March 2008 Budget (see Figure 1) suggested that the outlook for compliance with the rule was extremely tight, with debt forecast to peak at 39.8% of national income in 2010-11. Economic and policy developments since March have made the short-term outlook for debt worse rather than better, further increasing the possibility that the rule will be breached in the next two to three years. In this context, any reform that facilitated greater borrowing in the short term would be treated with suspicion.

The Treasury, however, is suggesting that a statement first made by Brown in 1999 implied that he always planned to reassess the sustainable investment rule when a new economic cycle was judged to have begun.

One reason to abandon slavish adherence to the rule at this particular moment is that compliance may well require cutting spending or increasing taxes at a time of weak economic performance. Relaxing or breaking the rules would likely come at the cost of further eroding confidence in the government's commitment to fiscal prudence. But given the outlook for the debt burden, this may be the lesser of two evils.

One way the government could have avoided getting into the current situation would have been to plan with a larger margin for error. …

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