Gordon Brown introduced two "fiscal rules", which have set the terms for debate over fiscal policy ever since. These rules were the "golden rule" - that over an economic cycle, the government should not borrow for current consumption but only for investment - and the "sustainable investment" rule - that net debt should only be a sustainable proportion of GDP, interpreted so far as meaning 40%.
I have never thought either of these rules worth very much, and it has been something of a mystery to me why Conservative politicians have placed such store by them. They were long ago discredited in the sight of those economists foolish enough to have been initially taken in by them, and in recent years the situation has gone beyond parody - in 2005, for example, the UK's macroeconomic credibility supposedly (if you placed great store by the fiscal rules) rested on the accounting definition of roads maintenance.
In my ever-humble opinion, the truth is that these were never rules with any intrinsic merit. Last week the Conservatives convened a conference at which they discussed reforming the fiscal rules - the key reform, apparently, being to achieve more "independence" in the assessment of whether they had been broken, as if somehow the problem with them was that everyone hadn't noticed when they were violated. Of course, that is nonsense. The government's fiddling with the timing of the economic cycle was noticed by everyone. The problem with the rules is much more fundamental than that.
First, the golden rule. Should government only borrow to invest over an economic cycle? No. This rule is daft. Firstly, it rests upon an entirely false distinction between government investment and government consumption. In the case of an individual, this distinction perhaps has some meaning - money I spend on buying shares might later be turned back into cash, whilst money I spend on dining out is presumably gone. But in the case of the government, the same distinction does not apply. For, unlike an individual, government investments are not an important source of future income. The government's key source of income is always its power to tax, and the amount available to be taxed depends on the performance of the economy as a whole, not that of government investments. In addition, things called "investment" by the government are rarely truly investments. For example, money spent on hospitals is not going to return money to the government in later years. A more interesting distinction for government might be between durable consumption (like a hospital) and non-durable consumption (like public sector salaries) but that distinction is not of any fiscal interest. From the fiscal point of view, what is of interest is the total amount of debt, not whether that debt was accumulated building hospitals or paying doctors. The investment/consumption distinction was driven, presumably, by the thought that government's tended to under-"invest" in infrastructure, because of short-termism. The evidence for this is generally rather confused and based on false New Labour narratives, and there is no reason why Conservatives should ever have accepted it.
Next, the golden rule is flawed because it rests on this idea of an "economic cycle". Now, it is true that we can, after the event, give a reasonable statistical definition of an economic cycle. But it is not possible, in principle, to say beforehand how long an economic cycle might last (there are economic theorems - theor-ems, i.e. consequences of theories, not theories themselves - that show this). The idea of an economic "cycle" has no theoretical justification. An "economic cycle" is nothing more than a term for "a while". It means, roughly, the period between when we all last screwed up until the next time we do it. And we screw up because we don't know what is coming. Thus, an "economic cycle" is, by its very definition, useless as a basis for planning anything - we cannot, in principle, say in advance how long it might be. The problem with the economic cycle is not, contra the Conservatives' conference last week, that the government can "cheat" by arbitrarily changing it. It is that the very thing itself is nothing more than a statistical artifice. I'll say it again: An "economic cycle" is nothing more than a term meaning "a while". And there is no reason at all why the government should not borrow to consume for a while.
Next, the golden rule is flawed because, even if we accept the false distinction between investment and consumption and even if we knew exactly how long an "economic cycle" would be, there would still be no reason why, in any particular cycle, we should not borrow to consume. For example, suppose that the UK, instead of having a national debt, were like Abu Dhabi and had a large national surplus - let's say, 50% of GDP surplus. Then suppose than an economic cycle were always seven years and one were about to start now. Why should we not borrow 10% of GDP over the next cycle to consume? Even as an individual, if I have a large positive bank account, and I feel like spending more than I earn for a few years, what is irresponsible about that? I'm rich, so I can afford to do it! There just isn't any good reason for us to have a rule that says, regardless of the country's personal level of debt/surplus, we should never borrow to consume over any economic cycle.
Next, suppose that I find myself in an awkward situation. Suppose that I had been planning to borrow only to invest over this economic cycle, but with two years to go there is a large economic shock and the economy is starting to go into recession, causing my current consumption to rise and my tax take to fall, driving me ever further away from the "golden rule". Am I really supposed to believe that the thing to do then is to raise taxes so as to keep the golden rule, even though doing so would probably make the recession worse?
Those that have much more sympathy with the golden rule than I do suggest a problem that I shall add to the list. They say that the rule needs to be forward-looking, so that from any point in the economic cycle what is of interest is whether current plans are expected to meet or violate the golden rule. So, they want bygones to be bygones (like the inflation target) - if we borrowed too much earlier in this economic cycle, oh well, that was a shame, but we are where we are, and the rule is broken only if, looking forward from here, we take decisions forecast to lead to consumption over the next economic cycle exceeding investment. (For readers that would like a sporting analogy, supporters of this point of view would probably regard the "Serena Slam" as truly a Grand Slam.) If I believed in the idea of the golden rule at all, I might have some sympathy with this point of view.
Turning now to the idea that net debt should be kept to 40% of GDP. Well, no-one believes in this. We have little real idea whether there is any optimal level of national debt - I don't believe that there is one, though some authors disagree (e.g. see "At a price! The true cost of public spending", Heath, Allister & Smith, David B., Politeia, April 2006) - but even if one thinks the optimal level is 40% or less, no-one (serious) thinks that debt should never be permitted to go above 40% of GDP, let alone thinking that to do so would be fiscally dangerous. The Eurozone has debt levels half that high again (in the high 60%s); Belgium and Italy have well over twice that level, yet service their debts fine. If we decided that it were useful to borrow for a while - say, during an extended recession - such that we ended up with debt above 40%, so what? Gordon Brown only invented this figure because when he came to power debt was above 40% - he wanted to paint the Conservatives as "fiscally irresponsible" and proffer a story about "Tory boom and bust" with high levels of debt and borrowing to fund consumption.
So, I've attacked the fiscal rules. I've said I don't think they need a little reform here and there - making them forward-looking, making the assessment of whether they have been broken "independent" and so on. I just want them ditched. So what rules would I want instead?
Answer: in general, none. We don't, as a general principle, need any fiscal rules of this sort. We don't need vast five-year expenditure programmes and fiscal plans extending out for whole parliaments. This is the thinking of the central planner, the tinkerer who thinks that it is the government that runs the economy. Conservatives have got themselves confused over this, because there is a scenario in which it is useful to have a medium term fiscal strategy: if public expenditure has got out of control, and we need a plan to rectify that. Now perhaps come 2010 or whenever we come to office, we will find that in our first few years in office it is indeed difficult to discipline the desire of our spending department ministers to over-expend. But I don't see that that is inevitable. From where we are, rather, I would see that as a mark of failure. Surely what we want from our spending department ministers is a culture of seeking to achieve as much as possible without government spending money. We may have had some years since 2002 of overly-rapid public expenditure rises, but we are most unlikely to face the cultural problems of the early 1980s.
What we need from government is to be told what it will spend and tax this coming year, what its capital budgets are for any particularly big-ticket items (e.g. Olympics, Trident II) in future years, some indication as to its aspirations for the expected longer-term trend path of future expenditure, and its near-term intentions (say, a guesstimate for next year, presented in a rough-enough sort of way, rather than as a prediction) for its fiscal stance. All else is unnecessary and probably hubris.
