Fiscal rules are a ‘self-awarded badge of honour’ that ‘make no difference’
Fiscal rules are “largely ineffective” and fail to impose discipline on public expenditure, a new report has said, bringing into question claims made by UK Chancellors and the International Monetary Fund that a clear list of targets can stabilise public finances.
Chancellor Rachel Reeves has held up her “iron-clad” fiscal rules, which hinge on changing forecasts made by the Office for Budget Responsibility (OBR), as evidence for her commitment to maintaining control over the public purse.
But based on analysis from various global economies, Oxford Economics’ emerging markets analyst Yash Adwani said fiscal rules make “no difference” to fiscal outcomes as bond markets were more likely to ”impose fiscal discipline”.
Adwani also questioned the IMF’s encouragement for countries’ finance ministers to adopt fiscal rules, suggesting that governments had used them as “self-awarded badges of honour” despite overseeing deteriorating economies.
“Fiscal rules and reputation make no discernible difference to actions or incentives,” the economist, who based his research on 99 countries since 2000, said.
“More charitably, rules and reputation do have a minor impact on incentivising efforts to reduce primary balances, but this is fully offset by opposing incentives to capitalise on any credibility earned to run more expansionary policies.”
The report also found that countries with a better reputation for meeting fiscal forecasts in the prior three years had severe deteriorations in their primary balances while having more rules did not lead to better performances in public finances.
Adwani concluded that governments may take more drastic measures to take control over public finances before rules are imposed but would often “relax” after they came into enforcement.
Reeves’ rules face criticism
The report follows criticism of Reeves’ fiscal rules, with unstable public finances leaving the UK with high government borrowing costs.
The Office for Budget Responsibility (OBR) estimates that debt interest payments will hit £113.7bn this year and £136.6bn by 2030, totalling more than the defence budget.
Former Bank of England Governor Mervyn King launched an attack on Reeves’ fiscal rules last year in an address to the House of Lords.
He took aim at the targets being set on a rolling basis, meaning the UK government is tied into forward-looking OBR forecasts rather than having to meet borrowing targets in outruns.
“The Chancellor of the Exchequer deserves sympathy for the difficult fiscal position which she inherited. But unfortunately her new fiscal rules are flawed.
“Although the OBR discusses risks to the outlook several years ahead, it presents just one precise number to which the chancellor is supposed to respond, and it does so every six months. This is no way to manage public spending.
“We owe it to our grandchildren to take seriously the challenge of reducing the national debt.”
Some Labour backbenchers, including former transport secretary Louise Haigh, have said fiscal rules have been used as an “economic straitjacket”, adding they had to be re-written to prevent “managed decline dressed up as moderation”.