Is there any point to fiscal rules if they’re often broken? Well, yes

There has been a big debate, including on these pages, about the government’s fiscal rules and the likelihood of them changing at the end of this month when the chancellor presents her first budget. There is nothing new, I should say, in fiscal rules, or the measures that are their basis, being changed.
Fiscal rules have been amended or abandoned so often that you sometimes wonder whether they are an endangered species. More to the point, is there any point to rules which, rather than guiding tax and spending decisions through thick and thin, are blown away when economic trouble occurs?
Before answering that, a bit of history. There is a debate about when fiscal rules were first adopted in the UK. They were formalised by Gordon Brown when he became chancellor in 1997.
Before him though, Nigel Lawson, Margaret Thatcher’s second chancellor, had rules. In his 1987 budget he announced a 1 per cent borrowing rule, so the budget deficit should not exceed 1 per cent of gross domestic product (GDP). A year later he revised it to a “balanced budget” rule, which was that the deficit should average zero when measured over the economic cycle. Neither stood the test of time, blown off course by the early 1990s recession. In the seven years after Lawson resigned as chancellor in late 1989, borrowing averaged more than 4 per cent of GDP.
Brown, when he became chancellor in 1997, established two rules. The first was the “golden rule” of only borrowing to invest, thus keeping the “current” budget deficit at an average of zero when measured over the economic cycle. The second, the “sustainable investment rule”, was to keep government debt below 40 per cent of GDP.
This was the most successful period for fiscal rules, helped by the absence of a recession or crisis. Debt stayed below 40 per cent of GDP from 1997 to 2008, ranging from 28.1 per cent to the 36.6 per cent Brown inherited. The current budget was in balance on average from 1997 to 2004, despite a big increase in public spending in the 2000s. There was, though, a fierce debate between the Treasury and the Institute for Fiscal Studies over whether the golden rule was met after 2004.
In the event, all bets were off when the financial crisis hit. In the six years from 2008-09, the current budget deficit averaged 5.5 per cent of GDP, with overall borrowing higher still. The golden rule bit the dust. So did the other rule, as debt broke decisively above 40 per cent of GDP, emerging from the financial crisis at 70 per cent.
And so it has gone on. “All the sets of rules that have existed since 2008 have been abandoned because at least one could not be met,” the Institute for Government (IfG) think tank noted in an assessment. “None of the deficit rules that directly targeted a particular date were met.”
It is not hard to see why. As the IfG puts it: “The economic circumstances of the last two decades undoubtedly contributed to the high rate of fiscal rule failure. Growth has been consistently weaker than expected, resulting in lower tax revenues — exacerbated by the twin shocks of the financial crisis and Covid. This stands in contrast to the decade 1997–2007 when economic conditions were benign.”
Abandoning or suspending fiscal rules when it is clear they can no longer be met is no bad thing. Otherwise governments would be faced with putting up taxes and slashing spending in a recession or crisis, measures that themselves would deepen the recession.
We come back, though, to the basic question. Is there any point to fiscal rules when they are so often broken?
To answer that, think of another area of economic policy — monetary policy. Suppose that two years ago, when inflation hit 11 per cent, there had been no rule for monetary policy, no inflation target. It provided at least a reassurance that the Bank of England had to aim to get it back to the 2 per cent target. Having a rule for monetary policy — the inflation target — has helped deliver lower inflation than if policy was unanchored.
It is also useful to look across the Atlantic for an example of unanchored fiscal policy, with both presidential candidates promising policies which will add to America’s already large fiscal deficit. The US has a debt ceiling, but that is regularly raised after a bit of argy-bargy between Congress and the White House. As it is, the US budget deficit is projected by the Congressional Budget Office to be 7 per cent of GDP this year, and to not fall below 5 per cent over the next ten years. In contrast, the most recent official projections put the UK’s deficit at just over 3 per cent of GDP this year and falling to just over 1 per cent over the next few years.
Fiscal rules can always be improved upon. The outgoing director of the National Institute of Economic and Social Research, Jagjit Chadha, set out a framework a few days ago. As he put it: “An overview of the government balance sheet, the changes since the previous year and how it is both sustainable in terms of the market demand for gilts but also in terms of tax revenues required above the returns from any assets held, would lead to a better set of choices over time. This overview would force the chancellor to be held to account for economic performance and not hide behind a forecast, which will always be wrong.”
One reason why the fiscal rules have changed so often is that every chancellor is looking to improve on those used by his or her predecessor. Perfection has so far eluded all of them. For all their faults, however, it is better to have fiscal rules than not have them. They act as a constraint, and we do not have to look back too far for the consequences of a chancellor and prime minister unconstrained by rules.