Why chancellors need fiscal rules

Good morning. Rachel Reeves has tweaked the UK’s fiscal rules, giving herself considerable wriggle room to spend on capital investment (she hopes to spend an extra £20bn a year having changed the fiscal rules she inherited from Jeremy Hunt to increase her headroom to do so by £50bn). Some thoughts on the purpose of fiscal rules and these changes in today’s note.

Money for nothing

Fiscal rules have three major uses. The first is to reassure markets and investors that you aren’t crazy, stupid or both. One reason why Rachel Reeves is setting out her tweaks to the UK’s fiscal rules in our pages and at the IMF is because she wants to tweak these rules without delivering Liz Truss 2: This Time In Red! This also explains why she is strengthening the UK’s fiscal police, or the Office for Budget Responsibility.

Whether that will work is not my department — read this excellent blog by Louis Ashworth over on Alphaville for more on that — which contains a lot of fun charts, including this one from Deutsche Bank:

However, there is also a political dimension to the strengthening of the OBR, which is to find ways to remind people that the Conservatives made Liz Truss prime minister and to continue to punch that bruise.

My worry here is that while the OBR is, in my view, a fantastic innovation that has improved the UK Budget process, there’s a trade-off between strengthening the OBR and making too many decisions by elected politicians subject to outside organisations. We’ll have to look more closely at the detail of what Labour ends up doing on this, but I do have some concerns about it.

This is the area in which Jeremy Hunt’s fiscal rules had already passed with flying colours: he stabilised the UK’s standing after Kwasi Kwarteng’s mini-Budget.

The second use for fiscal rules is that they are a device through which finance ministries control their spending departments. Hunt’s fiscal rule to have debt falling as a proportion of GDP in five years’ time was less good at this, because in practice the five year rolling target meant that the previous government could, and indeed did, use frankly implausible future cuts to make the sums “add up”. As Richard Hughes, chair of the OBR, put it:

Some people refer to that as a work of fiction — that’s probably generous given that someone has written a work of fiction. The government hasn’t even bothered to write down what its public spending plans are.

How effective Reeves’s tweaked rules are at this part depends on how exactly she will end up defining her commitment to get debt falling.

And the third is that they should discourage the finance minister of the day from making stupid decisions. 

One recurring stupid decision that chancellors of the exchequer have tended to make is to cut back on capital spending when they are in a hole, politically or economically. Indeed, this is essentially what Reeves herself did in the summer: cancelling the A303 Stonehenge tunnel scheme and Edinburgh’s planned exascale computer in order to meet in-year pressures.

It is also how Hunt was able to buy himself the wriggle room against his debt rule to make his cuts to national insurance, by pencilling in planned cuts to capital spending.

Reeves’s tweaked rule removes that incentive to trim capital spending in tough times, so in that respect it is a significant upgrade. Of course, your ability to benefit from that rule depends on many other things, not all of them in your control, as well as whether the tax incentives you are creating for businesses and individuals to innovate and invest are right.

So, while this rule is, on paper, a significant upgrade, the degree of the improvement depends very much on what else happens and what precisely Reeves does with it in next week’s Budget.

Now try this

I had a lovely time at the Royal Festival Hall yesterday, where conductor Marin Alsop and the London Philharmonia played work by Gustav and Alma Mahler.

Honesty compels me to admit that I don’t really like any of the work Alma did while Gustav was alive, but it was very interesting to hear them “in conversation” with one another as it were, and it was as good a performance of Mahler’s Symphony No 5 as I have ever heard. Here’s an excellent set of the whole cycle by Simon Rattle and the City of Birmingham Symphony Orchestra.

However you spend it, have a wonderful weekend!

Top stories today

• ‘Despondent’ shoppers | Consumer confidence in Britain has fallen to its lowest this year as households and businesses “hold their breath” for tax rises in next week’s Budget.

• Work schmerk | Keir Starmer said that anyone who owns shares and rental property is not a “working person”. The prime minister is coming under increasing scrutiny about what he means by the phrase “working people” in his manifesto given next week’s Budget is due to involve up to £40bn of tax rises and spending cuts.

• University entry gap widens | The gap between university entry rates for disadvantaged students and their peers in England has reached its highest level since records began in 2005.

• That sinking feeling | Local authorities in England are predicting a collective deficit of £9.3bn by 2026-27, almost four times the figure estimated for this year, according to research that underlines the scale of the strains on council financing.

• The shadow of the past | The Guardian reports that Keir Starmer has opened the door to non-financial reparations for the UK’s role in the transatlantic enslavement, as he came under pressure from Commonwealth leaders to engage in a “meaningful, truthful and respectful” conversation about Britain’s past. More recently today (speaking to the leaders in Samoa) he stuck to the line that he wanted to look forward and that the future should not be “in the shadow of the past”.