Those who feared that the government was about to embark on a reckless spending spree may now sleep safer in their beds.
Alistair Darling’s newfound devotion to Keynesian economics apparently has its limits. As the chancellor made clear in this week’s Mais lecture, he won’t be adopting a Viv Nicholson ‘spend, spend, spend’ approach to public funding.
Keynesian discretion will be constrained over the medium term through a new set of fiscal rules. The old fiscal framework had worked well but it would be ‘perverse’, Darling claimed, to adhere to this in the current financial climate.
It was an embarrassing reversal for both the chancellor and the prime minister, and yet it was hardly unexpected. The rules have been in terminal decline for some time and the recent economic turmoil presents an ideal justification for adopting a new philosophy.
But it’s crucial that the new rules, to be announced in the Pre-Budget Report, are pitched at the right level.
If Darling and Gordon Brown get this wrong they could end up with a long and deep recession and an unparalleled borrowing legacy to remember them by.
The good news is that there is room to manoeuvre. It could be argued that the current fiscal framework – involving the golden rule of borrowing only to invest and the sustainable investment rule limiting debt to 40% of gross domestic product – has been too restrictive.
UK debt levels are relatively low and, as Professor Steve Wilcox pointed out recently in PF, our definition of public sector net debt is much wider than the European equivalent.
Darling could increase the 40% limit, adopt the narrower debt definition and allow the sustainable investment rule to be met over the economic cycle, much as the golden rule is now.
It is also important, however, that the rules are independently monitored. In his Mais speech, the chancellor announced that the National Audit Office would audit the government’s fiscal performance over the previous cycle. If Darling wishes to restore some credibility, he should confirm in the Pre-Budget Report that the NAO will continue this role under the new structure.
