Early in his Autumn Statement to Parliament on 17th November, the Chancellor, Jeremy Hunt, announced two new fiscal rules:
“…I also confirm two new fiscal rules. The first is that underlying debt must fall as a percentage of GDP by the fifth year of a rolling five-year period. The second is that public sector borrowing over the same period must be below 3% of GDP. The plan I am announcing today meets both rules.” (Hunt, Autumn Statement 2022)
The concept of fiscal rules was first introduced by Gordon Brown in his 1998 budget. Brown had two rules. His first rule was called the ‘Golden Rule’ and required the government to balance the public sector current budget (revenue minus current expenditure) over the economic cycle. His second rule was called the Sustainable Investment Rule which required that national debt be kept at a “prudent level”. Brown set the prudent level of debt at below 40% of GDP in each year of the economic cycle.
Implicit in Brown’s Sustainable Investment Rule is the idea that high national debt is a bad thing. It’s an idea that would resonate with most households since their experience of debt is that they must reduce their standard of living to meet the interest and capital payments on their debt.
Brown stuck to his rules until 2008 when the Global Financial Crisis (GFC) forced their abandonment.
Nevertheless, the general idea of fiscal rules was accepted. All succeeding Tory chancellor’s would announce their fiscal rules with a certain amount of pomp. They asked that their budget statements be judged against their self-imposed fiscal rules.
George Osborne , in his first budget in 2010, retained a modified form of Gordon Brown’s Golden Rule but introduced a different 2nd fiscal rule which required that debt should fall as a share of GDP by 2015-16. He, thus, more firmly locked in the idea that national debt was a bad thing.
Subsequent Conservative chancellors, Philip Hammond, Sajid Javid and Rishi Sunak all in turn introduced their own fiscal rules. Requiring that debt must fall as a percentage of GDP has been a standard feature of these fiscal rules.
Sunak’s two rules in 2021 were firstly that underlying public sector net debt excluding the impact of the Bank of England must, as a percentage of GDP, be falling and second, in normal times the state should only borrow to invest in our future growth and prosperity. And now we have Jeremy Hunt’s latest rules restricting total government sector borrowing to 3% of GDP.
Labour, if, as seems very likely, they form the next government, are committed to continue the tradition of fiscal rules. In her 2021 speech to conference Rachel Reeves said: “… we would put in place fiscal rules that will bind the next Labour government to ensure we always spend wisely and keep debt under control…”
It is implicit in Reeves’s statement that national debt is a bad thing that needs to be controlled. Yet, it is evident from the Global Financial Crisis of 2008, the Covid pandemic and the current cost of living crisis that only greatly increased national debt was able to get us through these crises.
Why become preoccupied with the size of national debt and the ratio of national debt to the GDP? National debt should go up when it makes sense for it to go up. There should be no automatic assumption that an increase in national debt is a bad thing. It clearly was not in 2008, 2020 and 2022.
National debt is just the cumulative difference between government spending and government revenues (effectively taxation). A future labour government should state that government spending and taxation will be at whatever level is best for the society. The government should have a clear idea of what the result of their spending would be; for instance, spending money to train engineers to retrofit houses for insulation, the result of the spending would be an increase in employment (the engineers) and an increase in the population’s standard of living (through decreased expenditure on energy bills) and a concomitant increase in health and decrease in health spending, not to mention a reduction in CO2 emissions. Clearly a long term view of spending is required in real life, not an arbitrary fixed term.
This was very much the view of the role of fiscal policy (spending and taxing) that gained prominence in the years after Keynes wrote ‘The General Theory of Employment, Interest and Money’ in 1936. Such an approach to spending and taxation was articulated very clearly by one of Keynes most capable supporters, Abba Lerner, when he proposed the idea of ‘functional finance’:
“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science as opposed to scholasticism. The principle of judging fiscal measures by how they work or function in the economy we may call Functional Finance.”
If Labour adopts fiscal rules based on reducing the percentage ratio of national debt to GDP it will simply limit its ability to do what needs to be done when it finally returns to government. The Tories are not expecting to be in government after the 2024 general election. Hunt has structured his fiscal plan so that the reduction in spending required to meet his self-imposed fiscal rules happens after the next general election. Have no doubt that in the 2024 general election campaigning, the Tories will be demanding that Labour commit to these spending cuts when they form the next government. Labour should respond to such demands by stating that their spending and taxing plans will be based on the principles of functional finance and not on Jeremy Hunt’s self-imposed and arbitrary fiscal rules.