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From: Labour Affairs: Editorials
Date: December, 0001
By: Editorial

Editorial: Fiscal Rules

Fiscal Rules – A Scam To Justify Austerity

Early in his Autumn Statement to Parliament on 17th November, the Chancellor, Jeremy Hunt, announced two new fiscal rules:

“…I also confirm two new fiscal rules. The first is that underlying debt must fall as a percentage of GDP by the fifth year of a rolling five-year period. The second is that public sector borrowing over the same period must be below 3% of GDP. The plan I am announcing today meets both rules.” (Hunt, Autumn Statement 2022) The concept of fiscal rules was first introduced by Gordon Brown in his 1998 budget. Brown had two rules. His first rule was called the ‘Golden Rule’ and required the government to balance the public sector current budget (revenue minus current expenditure) over the economic cycle. His second rule was called the Sustainable Investment Rule which required that national debt be kept at a “prudent level”. Brown set the prudent level of debt at below 40% of GDP in each year of the economic cycle.

Implicit in Brown’s Sustainable Investment Rule is the idea that high national debt is a bad thing. It’s an idea that would resonate with most households since their experience of debt is that they must reduce their standard of living to meet the interest and capital payments on their debt.

Brown stuck to his rules until 2008 when the Global Financial Crisis (GFC) forced their abandonment. Nevertheless, the general idea of fiscal rules was accepted. All succeeding Tory chancellor’s would announce their fiscal rules with a certain amount of pomp. They asked that their budget statements be judged against their self-imposed fiscal rules. George Osborne , in his first budget in 2010, retained a modified form of Gordon Brown’s GoldenRule but introduced a different 2nd fiscal rule which required that debt should fall as a share of GDP by 2015-16. He, thus, more firmly locked in the idea that national debt was a bad thing. Subsequent Conservative chancellors, Philip Hammond, Sajid Javid and Rishi Sunak all in turn introduced their own fiscal rules. Requiring that debt must fall as a percentage of GDP has been a standard feature of these fiscal rules.

Sunak’s two rules in 2021 were firstly that underlying public sector net debt excluding the impact of the Bank of England must, as a percentage of GDP, be falling and second, in normal times the state should only borrow to invest in our future growth and prosperity. And now we have Jeremy Hunt’s latest rules restricting total government sector borrowing to 3% of GDP. Labour, if, as seems very likely, they form the next government, are committed to continue the tradition of fiscal rules. In her 2021 speech to conference Rachel Reeves said: “… we would put in place fiscal rules that will bind the next Labour government to ensure we always spend wisely and keep debt under control…” It is implicit in Reeves’s statement that national debt is a bad thing that needs to be controlled. Yet, it is evident from the Global Financial Crisis of 2008, the Covid pandemic and the current cost of living crisis that only greatly increased national debt was able to get us through these crises.

Why become preoccupied with the size of national debt and the ratio of national debt to the GDP? National debt should go up when it makes sense for it to go up. There should be no automatic

assumption that an increase in national debt is a bad thing. It clearly was not in 2008, 2020 and 2022.

National debt is just the cumulative difference between government spending and government revenues (effectively taxation). A future labour government should state that government spending and taxation will be at whatever level is best for the society. The government should have a clear idea of what the result of their spending would be; for instance, spending money to train engineers to retrofit houses for insulation, the result of the spending would be an increase in employment (the engineers) and an increase in the population’s standard of living (through decreased expenditure on energy bills) and a concomitant increase in health and decrease in health spending, not to mention a reduction in CO2 emissions. Clearly a long term view of spending is required in real life, not an arbitrary fixed term.

This was very much the view of the role of fiscal policy (spending and taxing) that gained prominence in the years after Keynes wrote ‘The General Theory of Employment, Interest and Money’ in 1936. Such an approach to spending and taxation was articulated very clearly by one of Keynes most capable supporters, Abba Lerner, when he proposed the idea of ‘functional finance’:

“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall be undertaken with an eye only to the results of these actions on the economy and not to any establishedborrowing from the private sector in order to finance its spending. In the MSM account, the markets are seen to have the power to cancel parliament’s spending plans if they do not like them, by not buying issued bonds.

In fact the opposite is happening. The government spends into the economy first and then issues bonds which allow the private sector to put their newly acquired wealth (due to the government spending) into a riskless, interest earning asset. The private sector is not doing the government a favour by buying the bonds and so allowing the government to implement its parliamentary approved program. On the contrary, it is the government that is doing the private sector a favour by allowing them to put their savings into riskless, interest earning government bonds.

The government, if it wants, can completely control the price and interest paid on these. A bond is just a piece of paper that promises to pay the owner money on certain dates. For instance the government may sell a piece of paper that promises to pay £3 on March 1st each year for 5 years and a final payment of £100 on March 1st on the 5th year. It could offer this piece of paper for sale to the private sector at a fixed price of £100. Or it could auction it to the private sector. However auctioning it means that the private sector determines the price of the bond.

Auctioning bonds is probably a bad thing. It would be preferable if the bonds were issued at a price decided by the government. If the private sector chooses not to buy them at that price then they would remain unsold. It would be even more preferable if the government ceased to issue bonds. The private sector could instead put its savings into non-tradeable

National Savings and Investment type schemes. This would make clear what is really going on. The government is not borrowing when it issues bonds. Rather it is helping the private sector to achieve its saving objectives. The black hole is not just “nonexistent”. It is a useful fiction, designed to increase the private sector at the expense of the public sector.

By not spending money in the public sector, the government runs down the public sector and pushes people towards the private


For example, by not spending money on nurses pay and recruitment, the government creates a situation where nurses are working shifts that are undermanned and excessively long. The result is nurses leave to enter the private health sector. And possibly patients choose to go private where they will be treated by nurses that have more time for them.

The idea that “there is no money” hides this manoeuvre.

The Non-Existent UK Fiscal Black Hole

The story we are being told about UK government finances by virtually every main stream media (MSM) commentator goes something like this.

The government wants to spend more than it is raising in taxes. This means that it will have to borrow from the private sector. The private sector may choose not to lend to the government. In that case the government will have to abandon its spending plans. Alternatively, the private sector may be prepared to lend to the government, but only at high interest rates which will increase the cost of government borrowing.

This story is inaccurate and completely confuses the order in which spending and borrowing happen in the UK economy. The correct story is as follows: A government gets parliamentary approval for its spending plans.

The Bank of England (BoE) is then, by law, required to make available to the government whatever money is required to finance the parliamentary approved expenditure. The BoE creates the money and puts it into the government account.

The government spends that money into the economy. The private sector is now richer by that amount.

The Debt Management Office (DMO), which is an arm of the Treasury, calculates the difference between government spending and taxes levied and issues government bonds, the value of which broadly matches that difference.

The private sector can buy these bonds.

It is important to note the sequence here. The government spending happens before bonds are issued and is not dependent on the issuing of bonds. Issuing bonds is presented by the MSM as the government traditional doctrine about what is sound or unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science as opposed to scholasticism. The principle of judging fiscal measures by how they work or function in the economy we may call Functional Finance.”

If Labour adopts fiscal rules based on reducing the percentage ratio of national debt to GDP it will simply limit its ability to do what needs to be done when it finally returns to government. The Tories are not expecting to be in government after the 2024 general election. Hunt has structured his fiscal plan so that the reduction in spending required to meet his self-imposed fiscal rules happens after the next general election. Have no doubt that in the 2024 general election campaigning, the Tories will be demanding that Labour commit to these spending cuts when they form the next government. Labour should respond to such demands by stating that their spending and taxing plans will be based on the principles of functional finance and not on Jeremy Hunt’s self-imposed and arbitrary fiscal rules.