Mark E Thomas and Vince Gomez argue that if Labour sticks too literally to its Fiscal Rules, it will fail to deliver, so creative thinking is needed.
When he became Chancellor, Jeremy Hunt set out new Fiscal Rules in an effort to appear responsible after Truss and Kwarteng. Even before she became Chancellor, Rachel Reeves – also in an effort to appear responsible – said that Labour would follow very similar rules: she said, “We will not borrow to fund day-to-day spending, and we will reduce the national debt as a share of the economy”
That sounds rather restrictive, raising the question: Will these restrictions prevent Labour from successfully rebuilding the UK?
The UK cannot afford a narrow interpretation of the rules. Although most commentators treat the Chancellor’s Fiscal Rules as being, in some sense, rules of economic probity, they are arbitrary – each new Chancellor makes up his or her own. In fact, we have had at least nine iterations of these rules since they were initially adopted by the UK government in 1997.
If the Fiscal Rules are not economic rules, what are they? They are political devices for Chancellors, which can serve at least two purposes:
- Appearing responsible – this was Gordon Brown’s thinking in 1997, as it was for Hunt, who wished to distinguish himself from Kwarteng; and Reeves, who had to tackle the media narrative of ‘Labour fiscal irresponsibility’; or
- Giving cover for austerity – a chancellor aiming to shrink the state can claim to be ‘responsible’ and ‘not ducking the difficult decisions’ if they follow their fiscal rules. This enabled Osborne to avoid scrutiny for his damaging austerity programme, and it would have given similar cover to Hunt had the Conservatives been re-elected.
The Fiscal Rules are usually interpreted narrowly, as though Britain were still on the gold standard (see box: Fiat takes the brakes off).
In the UK, we are not on the gold standard: we have a fiat currency system where the government can create money. Yet, there almost seems to be a deliberate misunderstanding by politicians and commentators of how a fiat system works. Hardly any analysis of government finances in the media makes the point that the government can and does create money whenever it needs to – £895 billion since 2009.
Given that it is inconceivable that this enormous power to create money has no economic impact, it is extremely strange that it is so seldom even mentioned. We made this point in more detail in our Submission to the House of Lords Inquiry into Debt Sustainability. We were therefore astonished to see that the word fiat does not occur once in the Inquiry Report.
If Reeves adopted Hunt’s intended interpretation, which is that the rules should be met without taking advantage of our fiat currency system, she would be unable to avoid austerity without significant tax rises, which Labour have been trying to avoid.
£19 billion in cuts for unprotected departments by 2028-2029 are baked into the latest Budgetary figures.
According to the Resolution Foundation, £19 billion in cuts for unprotected departments by 2028-2029 are baked into the latest Budgetary figures. This would be devastating for Britain’s already failing public services. There is increasing evidence that another round of austerity would be unthinkably damaging (and not, as we have seen since 2010, even help bring down the ratio of debt to GDP). We cannot afford a narrow interpretation of the Fiscal Rules.
Government borrowing and debt need not be barriers. Fortunately, in our fiat currency system, a shortage of money is never an excuse for inaction. And we need action on a grand scale now.
Two kinds of spending are needed: day-to-day and investment. The Fiscal Rules are most restrictive on day-to-day spending. But given how much of what needs doing can be seen as long-term investments for the country’s good – a green transition, rebuilding crumbling hospitals and schools, new technology, etc. – that opens up a lot of wriggle room.
We also need to rethink how we estimate the long-term impact of investment spending on the economy (see box: Investment works).
The OBR currently assumes a maximum multiplier of one, meaning that, in their forecasts, the government can never stimulate more growth than it spends—indeed, overall, their forecasts assume that government spending ‘crowds out’ private sector spending and, therefore, harms the economy.
This assumption flies in the face of empirical reality. A recent IMF report found that real-world evidence points to a powerful ‘crowding-in’ effect: “a dollar of government investment raises private investment by about two dollars, and output by 1.5 dollars.”
If Budgetary Responsibility is assessed in such a counterfactual way, what hope do politicians have of formulating sound Budgets? Is it any wonder that we persistently underinvest?
Further good news is that, even without more borrowing, there is enormous scope to reduce ‘leakage ’ where money that should be public money is either never collected or leaked out, not to the public but to private beneficiaries — for example, the COVID fraud. Tackling the leakage from government finances will provide £10s of billions extra for worthwhile spending. In total, if all the leaks could be completely plugged, the benefit to UK citizens in general (though not those who have been on the receiving end of the leakage) would be a truly staggering £250 billion per annum. And even a fraction of this total would enable Reeves to meet her fiscal rules.
Regarding the fiscal rule on reducing debt, around 25% of so-called government debt is currently owed to the Bank of England (a subsidiary of the Treasury). To hit the target, that debt could simply be cancelled as if it were corporate debt.
The rule about debt reduction is, in any case, reminiscent of Saint Augustine’s prayer: “Lord, give me chastity and continence, but not yet.” It hinges on uncertain future elements: expected shifts in public finances and economic predictions for the upcoming five years, ultimately ending in a hypothetical point that is never actually reached. Both factors are fraught with significant unpredictability, as the events since 2019 have shown us.
Considering the above factors, it is clear that the Fiscal Rules need not prevent a determined government from doing what the country needs.
The real issue is physical resources.
The real issue is physical resources. Despite the points above, there are real barriers – governments can always create money when needed, but they cannot print teachers, doctors or peas and carrots.
It is often said that we cannot “afford” to tackle food poverty amongst our most vulnerable children in schools. Over the last four decades, the prevalent economic ideology has largely convinced two generations of citizens, including policymakers, that the state is powerless and incapable of providing the necessary goods and services that a modern society can deliver. The fact that the state was the only agent able to support the economy during WWII, the Global Financial Crisis and, most recently, COVID seems to have been forgotten.
As John Maynard Keynes said in 1942, “Assuredly we can afford this and much more. Anything we can actually do, we can afford. Once done, it is there. Nothing can take it from us. We are immeasurably richer than our predecessors. Is it not evident that some sophistry, some fallacy, governs our collective action if we are forced to be so much meaner than they are in the embellishments of life?”
It is a question of peas and carrots, not one of gold.
The question is not whether we can find the money to provide the 4.3 million children living in poverty in the UK with free school meals but whether we have the protein and vegetables available to us as a country to deliver. It is a question of peas and carrots, not one of gold. We should discuss farming policy, food security and import substitution, not where we can find the money.
Repairing the UK will require diverting real resources to rebuilding: we will need to reduce demand for certain goods and services via taxation elsewhere in the system to free them up to tackle vital national challenges without stoking inflation. So, while the state is in no way dependent on private sector taxes to give it the money for spending, carefully targeted tax is necessary to remove some private spending capacity and prevent inflation.
During WWI, Keynes had to figure out how to reshape the economy without stoking inflation or starving the poor. He thought radically; we need radical policies now.
It is certainly true that the UK faces a major (and difficult) task of national renewal after the last 14 years. It is not true that we cannot find the money to do so, and it is not even true that the government would have to ditch its Fiscal Rules to succeed. But a narrow interpretation of the rules would indeed guarantee failure.
The UK cannot afford to allow gold-standard thinking to derail the effort to rebuild the nation’s fabric.
