As the economy still refuses to respond to the chancellor’s policies, should he breach his fiscal rules?
Fiscal rules are meant to discourage excessive debt in an economy. They protect the long-term interests of a nation against the short-term temptations of its politicians and voters.
Well, that’s the theory anyway. Recent history does not suggest much success in this department. The eurozone has a huge debt crisis, despite the best efforts of the Stability and Growth Pact, and a legislative cap in the US has not prevented national debt passing the $16 trillion level.
Back at home, of course, we have the unfortunate experience of Gordon Brown’s tenure as chancellor. Brown made great play of his Golden Rule and Sustainable Investment Rule, but tweaked the definitions so many times that they eventually became worthless.
George Osborne, the current incumbent at 11 Downing Street, had an opportunity to learn from his supposedly prudent predecessor’s mistakes. He introduced two rules in the Emergency Budget of June 2010 – a fiscal mandate and a supplementary target.
The fiscal mandate promises to eliminate the structural deficit over a rolling five-year period, while the supplementary target is a commitment that public sector net debt will be falling as a percentage of GDP in 2015/16.
Unfortunately for Osborne, the curse of the fiscal rules appears to be heading his way. Economists of every conviction are queuing up to predict that the supplementary target will be missed by some distance.
A lack of growth has stymied the coalition’s deficit reduction plan, and the expectation is that Osborne will admit the game is up when he delivers his Autumn Statement on December 5.
The problem is clear, but the solution is not. As Carl Emmerson and Gemma Tetlow of the Institute for Fiscal Studies point out in this month's magazine (Biting the bullet on fiscal targets), the chancellor has three options: continue with current policies and miss the target; change the policies by increasing taxes or cutting spending further; or amend the target.
The betting is that he will take a political hit and abandon the target. This will be a huge blow to Osborne’s credibility – an experience much worse than being booed by thousands of spectators at the Paralympics.
But it may be the best outcome for the nation in the long run. Further austerity will not stimulate an economy that is already on its knees. Moreover, additional cuts to public services and welfare payments would threaten basic social safety nets.
The IFS recommends the chancellor bites the bullet and abandons his target. He would do well to listen.
This article first appeared in the October issue of Public Finance
