Rachel Reeves warned ‘dysfunctional’ fiscal rules are hammering economy
Rachel Reeves has been dealt a scathing assessment of her economic policy by a top think tank, which likened her approach to a driver who was “watching the speedometer” while ignoring other conditions.
The Chancellor is facing calls to scrap the self-imposed fiscal rules that prevent her from borrowing to pay for day-to-day spending and require debt to fall as a percentage of GDP by 2029/30.
Economists at the Institute for Fiscal Studies (IFS) said the focus on ‘fiscal headroom’, the margin by which the government meets the rules based on forecasts, leads to “spurious” policy change, which ramps up volatility.
“This framework is achieving neither sustainable public finances nor credibility with financial markets,” Ben Zaranko, economist at the IFS, wrote.
“The central contention of this report is that the UK fiscal framework has some desirable features but is not delivering good outcomes. We are in a bad equilibrium.”
Zaranko drew the comparison to a driver and warned: “You cannot assess whether you are driving safely solely by looking at the speedometer: you also need to worry about traffic conditions, the state of the roads, the condition of the car, the weather, and much else.”
The report comes weeks ahead of the Chancellor delivering her Spring Statement, where reports suggest Reeves will attempt to use the event to drive Labour’s pledge of only one fiscal event per year.
The Treasury is aiming for the event to restore confidence through delivering no drastic policy or spending changes, the Telegraph has reported.
Reeves’ fiscal rules ‘do not ensure sustainable public finances’
The IFS said the “current equilibrium is producing such dysfunction that the time has come” to try something new.
It called for a radical reform of the post-2029 Parliament, in which the Chancellor delivers a high-profile speech outlining broad fiscal objectives in narrative terms rather than in fixed terms.
This would then lead to the Treasury selecting eight to 10 indicators that the Office for Budget Responsibility would forecast a red-amber-green status to based on defined thresholds.
“The current set-up all but guarantees policy adjustments in response to small changes in the forecast… macroeconomic volatility is mainlined into policy volatility, which adds unnecessarily to economic uncertainty,” the IFS said.
Tensions flared over economic forecasts ahead of the 2025 Autumn Budget leading to Reeves battling accusations of “misleading the country” after teasing a downgrade in forecasts that ultimately did not come to fruition.
In her early November speech and subsequent media appearances, the Chancellor and fellow government ministers heavily implied there would be a manifesto-breaking hike to income tax in a bid to meet fiscal headroom after a productivity downgrade.
But the OBR’s economic forecast would later reveal a surge in tax receipts – due largely to inflation – more than covered the £16bn downgrade.
Reeves has consistently said that her fiscal rules are “non-negotiable” and blasted her predecessors for failing to make the numbers work.
The IFS said fixation on headroom “does not make for good policy-making, it does not ensure sustainable public finances, and it stretches credulity and credibility with financial markets.”
A Treasury spokesperson said: “The government’s non-negotiable fiscal rules help to keep interest rates low while also prioritising investment to support long-term growth.
“In the Budget, we doubled the fiscal headroom, and we are cutting borrowing more than any other G7 country with borrowing forecast to be the lowest in six years as share of GDP.”