Fiscal rules are not worth the paper they are written on

Posted on November 28 2019

The Guardian has a feature on a claim by the Resolution Foundation this morning, saying:

The thinktank warned in a report that Labour and the Conservatives are already on course to break their new fiscal rules, announced less than a month ago, as a result of pledges made in their manifestos and in leadership speeches.

The main parties have adopted tax and spending rules that commit them to balancing day-to-day spending over three years in the case of the Tories or five years in Labour's case, putting a limit on debt servicing costs and, in Labour's plan, improving the value of public assets over the course of the parliament.

The Foundation said that fiscal rules were important for the government's stewardship of the public finances, and testing its economic priorities.

They added:

However, it warned that fiscal rules “are only useful if they are credible and adhered to”. It added: “Failing to meet them at the first opportunity — as both main parties risk doing — would damage rather than enhance the UK's economic credibility.”

There are three things to say. The first is that the Resolution Foundation is, I think I am safe to say, the home of the dire economic strategy and fiscal rule promoted by Ed Davey for the LibDems that suggests that a government should run a permanent surplus, so restricting money supply and guaranteeing simultaneous austerity. Nothing that they say about Labour and the Conservatives should ignore this fact: bias is built into their comments.  Nor should the economic illiteracy that the Davey policy reveals be ignored if it does, as I suspect is the case, reflect the Resolution Foiundatiion view on these matters.

Second, a fixation with fiscal rules is simply absurd in an era when we know that a) there is a macroeconomy, which fiscal rules deny by adopting a household analogy b) money is created by governments and so they cannot be constrained by a shortage 0f it and c) the impact of fiscal rules has always been to constrain the role of government, impose austerity and to create unemployment as a wholly unnecessary and profoundly socially costly buffer against inflation in the interests of the wealthy.

Third, a fiscal rule is the type of measure a book-keeper would impose on the economic strategy of a country: they ignore what's really going on and instead suggest that the priority is keeping the ledgers nice and tidy. It is small-minded thinking, at best. Instead we need big thinking, the sort a finance director or CEO might do (and yes I am aware I am at risk of using a corporate analogy). The question is what would that be?

It would be to ask what the country wants to achieve, which I would always suggest would be full employment with net carbon usage and low inflation.

Then the finance question becomes one of how that can be delivered, which a combination of  modern monetary theory and some lateral thinking on savings, pensions and the role of government borrowing answers.

But there is no fiscal rule in this: there is finance as a servant to the real goals that a government wants to fulfil, and not the economy acting as a servant to finance.

The Resolution Foundation is putting finance first. Like the Institute for Fiscal Studies what it shows is that however good it is at micro issues it cannot do macro thinking, or as a result comment on macro policy. Before it does so again it really does need to do some basic in-house economic education because right now it's quite emphatically doing more harm than good, both to itself and others, with such commentary.

I'd start by noting that fiscal rules are not worth the paper that they are written on. Real economic and social goals are.

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19 Responses

  1. AMcG says:
    November 28 2019 at 8:52 am

    Why does this read like such common sense? Good job Richard.

  2. JonM says:
    November 28 2019 at 10:33 am

    At a meeting over a year ago, I challenged John McDonnell on the FCR and the dangers it posed for a Labour Chancellor. He was convinced the “City” would punish a Labour government if the Debt/GDP ratio went too high (there is no such thing as “too high” for a currency-issuing government with debts in its own non-convertible currency). I explained that I was one of those working in the City and that the FCR would hamstring him. He even went so far as to (falsely) claim that Prof Bill Mitchell had said the FCR was “fine”. We are now seeing the FCR losing the C in its name before Labour have even been elected. James Meadway and Simon Wren Lewis have a lot to answer for.

    • Richard Murphy says:
      November 28 2019 at 10:53 am

      I agree

      And Bill most emphatically did not agree!!!

    • Helen Schofield says:
      November 28 2019 at 11:33 am

      As always the failure to publish an official explanation of how the UK monetary system works (deliberate in my opinion) allows so many individuals and organisations to make nonsense up about how it does. This has been a curse in the UK since the end of the Second World War. Many politicians are contemptible for refusing to recognise this most important basic essential and this turns by far the vast majority into vacuous wind-bags claiming to be acting in the interests of the well-being of the country. Now we have climate change to contend with and many still have their heads in the sand and their rumps in the air!

  3. Paul Hunt says:
    November 28 2019 at 11:15 am

    The focus has to be on why this damaging nonsense persists and what can be done to change the narrative and to demolish it.

    In the first instance, there is much talk about the economic and fiscal illiteracy of the right and their success in embedding it in the MSM. But the corporate capitalist elite and the high net worth individuals (and most of the the professional flunkies and tame academics they retain plus the politicians, policy-makers and regulators they have suborned) know that this is nonsense, but it serves their purposes. They live in dread and terror of democratically elected governments changing the economic rules to benefit the vast majority of citizens at their expense. Therefore they have employed every means to ensure that the “conventional wisdom” is characterised by a small state, minimal regulation, low taxation, fiscal restraint and the dominance of monetary policy enforced by an allegedly “independent” central bank.

    This edifice of nonsense has to be dismantled plank by plank and it will require a cultural and generational change in the same way as this nonsense was embedded over the last 40 years. But, at least, the dismantling has begun.

    The obsessive focus on fiscal restraint and fiscal balance should be an immediate target. Currently almost all UK sectors are net borrowers and the Rest of the World (RoW) is the sole net lender so as to achieve an overall balance. Economic stabilisation matters (this is where some of MMT’s assertions and prescriptions make me uneasy). This reliance on external financing is risky and potentially unsustainable. But it does not mean that the government should be the sole sector required to reduce its net borrowing so as to reduce the reliance on external net lending. Yet this is the nonsense that’s advanced.

    The function of government in this instance is to implement policies that will enhance the productivity and the efficient functioning of the other sectors so as to reduce overall domestic net borrowing and the reliance on external lending. And if this requires more government borrowing, so be it. Taxation plays an important role, but its primary objectives should be redistribution, providing economic incentives and taxing away economic rents, and not be obsessionally focused on satisfying some misguided fiscal rule.

    However, equally, there is an obligation on external net lenders internationally to reduce and recycle their surpluses to boost their domestic demand. Unfortunately there is a global asymmetry in the enforcement of these obligations. Net borrowers are punished; and net lenders are lauded. This can be changed only via the EU, the IMF or other multinational arrangements. (However, the pressure does seem to be increasing on Germany to mend its ways and major transformations from investment-led to consumption-led growth are taking place in the East Asian surplus economies.)

    Another plank of this nonsense is the obsessive focus on relating a stock (public debt) to a flow (GDP). The minutiae of GDP is analysed beyond tedium, but there is no commensurate assessment of the stock of physical, human and environmental capital that this debt finances (or, indeed, of the contribution to societal well-being).

    I accept that Labour can’t demolish much of this nonsense in the intensity of an election campaign, but it is ignoring the external balance, locking itself in to nonsensical fiscal restraint and unnecessarily creating huge hostges to fortune with its ill-thought through nationalisation and worker-participation plans.

  4. Paul says:
    November 28 2019 at 11:21 am

    Hi Richard is there a simple infographic or similar, that one can share with laypersons to explain MMT?

    Could you create one?

    I would be willing to chip in (creating one) if that would help.

  5. terry Brazier says:
    November 28 2019 at 12:18 pm

    Simon Wren-Lewis is a class act..

  6. brian faux says:
    November 28 2019 at 1:54 pm

    Now whenever I see `tax and spend` I think `paste and cut`…

  7. Pilgrim Slight Return says:
    November 28 2019 at 5:13 pm

    I am reading Martin Wolf on the side line on the blog.

    He apparently does not like the Tory Government but cannot bring himself to vote Labour. But he still wants ‘reform’.

    The poor lad doesn’t seem to know what he wants, or know how to recognise it even if it is right in front of him. The way in which market theory he is wedded to is so unrelated to reality is why I’m sure that Wolf – and many others – are suffering such cognitive dissonance.

  8. Pilgrim Slight Return says:
    November 30 2019 at 5:37 pm

    ‘Fiscal Rule’ = Fiscal Fool