jamesz

Fiscal rules, growth and the ZLB

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Yesterday I wrote that the consequence of a fiscal rule with a short horizon has been austerity, which delayed the UK’s economic recovery. Of course, that analysis misses a very important element of the recent recession, which is that the UK’s monetary policy was at the ZLB. That greatly increased the effect of fiscal policy on GDP in a way that wouldn’t happen in normal times. It’s also why Portes and Wren-Lewis recommend that any fiscal rule be suspended during periods where monetary policy is at the ZLB. So why am I really worried about a growth cost that is only realised in very unusual circumstances?

If the ideas about secular stagnation turn out to hold water then we may be hitting the ZLB far more often in the coming decades. Even if that doesn’t eventuate, real interest rates have been trending down for a long time, which has led some people to recommend a higher inflation target to avoid the ZLB in future. The upshot is that, unless there are changes to the standard monetary policy regime–flexible targeting of 2 per cent inflation–high fiscal multipliers and fiscal activism may become a regular occurrence. If it does then the government’s fiscal rule had better work during those times, too.

jamesz

Why fiscal rules matter: growth

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Last week I discussed the importance of good fiscal rules for sustainability, but the recent mess in the UK has demonstrated how poor rules can inhibit growth. When the Government took office in 2010 it faced a startlingly high deficit. It promised to eliminate that within five years, which happens to be the length of a Parliament in the UK. That’s probably not a coincidence. As Portes and Wren-Lewis point out in their paper, Governments like operational targets that they can achieve within their term of office. If you face a big hole in your budget then promising to fix it within the decade is no good if you might only be in power for half that time.

That has important consequences for the way surpluses and deficits are dealt with. It means that governments tend not to save surpluses beyond their term because they reap little benefit from it. They also attempt to close deficits within the term, which can be too rapid when the deficit is large. The recent recession in the UK is a textbook example of the latter problem. Read more

jamesz

Should the OBR cost Opposition proposals?

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Today has seen a debate over whether the Office for Budget Responsibility should cost Opposition policies. Sajid Javid appeared on the BBC to defend the Government’s decision not to allow it. He avoided criticising the idea but pushed the Government’s line that now is not the right time to extend the OBR’s mandate. On the other side of the debate, Simon Wren-Lewis criticises the Government for delaying.

I am a big fan of extending the OBR’s responsibilities but there are solid reasons for the Government to demur. Read more

jamesz

Simon Wren-Lewis on the UK’s new fiscal rules

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Simon blogs on the new fiscal rules and largely agrees with our view:

Getting the debt to GDP ratio to fall at some stage is a good idea, but having a target for a specific year is silly. It is not optimal because if some shock hits the economy before 2016/7 which means debt tends to rise relative to GDP, it is crazy to try and counteract that to meet the target in such a short space of time. It is not effective because it can be gamed by the government fiddling the timing of expenditures.

…

Having a five year rolling target for the deficit allows fiscal policy plenty of time to adjust to shocks. We saw this in action over the last few years, as the Chancellor was able to reduce the pace of fiscal consolidation from 2012 when the economy failed to recover as quickly as he had hoped. Changing this mandate from five to three years gives any Chancellor less time to adjust, which is why it is a backward step.

jamesz

Why fiscal rules matter: sustainability

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Before Christmas I wrote a couple of posts on fiscal rules and you might very well be asking why it really matters.

The first reason is that the current trajectory of public spending is unsustainable, but not in the sense that the Government means it. Sustainability in public spending should be measured over decades, not a single Parliament. The question is whether the current policy settings can be maintained indefinitely.

This is a chart of the UK’s debt-to-GDP over the past three centuries combined with the Office for Budget Responsibility’s latest long-run projections through to 2063-64.[ref]I have not used the OBR’s central projections here, which assume that health productivity more than doubles for the next fifty years. Instead, I have used the scenario that assumes productivity remains at historical levels.[/ref]

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jamesz

The UK’s new fiscal rule won’t last

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This post draws upon a blog I wrote for The Reformer.

A few days ago I wrote about the lessons that can be drawn from the recent history of the UK’s fiscal rules. This post measures the Government’s new Charter for Fiscal Responsibility against them. The Charter sets out the Government’s fiscal rule and requires the Office for Budget Responsibility (OBR) to assess Budgets against it. The new Charter lightly updates the previous version in two ways:

  1. It requires the Government to forecast a cyclically-adjusted, current account surplus within three years, rather than the previous five years.
  2. Public sector net debt should fall as a percentage of GDP in 2016-17, a year later than in the previous Charter.

Now compare against the lessons from history.
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