By backing a new Charter for Budget Responsibility, the main political parties in Britain want to persuade you that they’re legally obliged to balance the books within three years. Fortunately, it’s not a serious commitment.
In reassuringly convoluted terms, the charter actually sets itself: “A forward-looking aim to achieve cyclically-adjusted current balance by the end of the third year of the rolling, five-year forecast period.”
This is supported by “an aim for public sector net debt as a percentage of GDP to be falling in 2016-17”, effectively confirming that the budget has to be in surplus by that year. The phraseological genius here, of course, is to specify aim and not commitment.
When the Bank of England was made operationally independent in 1998, it was told to aim for a medium-term inflation rate of 2%. Inflation (on the chosen consumer-price index) stayed above 2% every year from 2005 to 2013. Yet the bank was not forced to raise interest rates, and actually found scope to relax monetary policy, as it never ceased to pursue the “aim”. This year, inflation has finally dropped below 2% – the medium term just turned out to be eight years, rather than 2-3 as previously assumed.
Because the charter’s aims are so vague, the shadow chancellor, Ed Balls, was able to sign up to it within minutes of its release. Balance is only needed in the “current budget”, which means that he (and coalition parties, if re-elected) can continue to borrow for publicly-funded infrastructure projects and other capital spending, within the new rules.
And because the balancing commitment applies to the “cyclically adjusted” deficit (which essentially assumes the economy remains at a normal level), the current budget could still be unbalanced in 2017. The chancellor will simply explain that the economy has still not returned to full capacity, so that spending will be lower (and tax revenue higher) once it fully emerges from cyclical downturn.
It might seem underhand, but in an uncertain world, these fiscal loopholes are sensible, even essential. Committing the government to balancing the budget in 2017/18 – in anything other than the charter’s deliberately vague terms – would tie policymakers’ hands in ways that damage still-fragile investor and consumer confidence. Despite setbacks this year, the budget deficit is already on course to disappear during 2017/18 and move into a small surplus in 2018/19, according to the independent Office for Budget Responsibility.
If all goes well, there will be no recurrence of unexpected shocks such as the financial meltdown of 2008, which forced the previous government to run a wide deficit as it rescued the banks and absorbed the rise in welfare costs. But it is by no means guaranteed. The risks include a further euro zone downturn, more international conflict, and a possible household-sector crisis when interest rates start rising again.
If problems recur in the financial, corporate or household sectors, pushing the economy back towards recession, higher budget deficits are usually the most effective countermeasure. Governments which borrow more in the short term can bring forward the moment when a revived economy allows them to start paying down debt – a lesson of which the US has shown better understanding than Europe in the years since 2008.
That’s because the public deficit can revive the economy if the private sector is investing too little (or saving too much) to keep GDP growing.
If GDP doesn’t grow, then the only way to halt the rise in public debt is to impose massive budget cuts – which may be self-defeating, as they further delay the return to growth. The present chancellor, after tightening the budget plans in 2010, suffered an interruption of growth until 2013. That three-year derailment is the principal reason why he missed the original (2015) budget-balancing target, and must enforce unprecedented public-service cutbacks if he is foolish enough to interpret the new target literally.
Martyrs to Maastricht
The euro zone gives a sad reminder why rigid budget parameters are the height of fiscal irresponsibility. More than 20 years ago, prospective members of the European Monetary Union signed up to the Maastricht Treaty’s “convergence criteria”, which included commitments to keep fiscal deficits below 3% of national output (GDP) and public debt below 60% of GDP.
Where are they now? The overall fiscal deficit for the 18-member euro zone finally dropped below 3% of GDP last year. But some big members (including Spain and France) are still well above this, and others (notably Italy and Germany) have squeezed below it only by stubbing out their GDP recovery.
Meanwhile euro zone public debts have risen inexorably, to average 93% for the whole zone, with only the micro-states of Estonia, Latvia and Luxembourg still below 60%. This is because of, and not despite, attempting to keep fiscal deficits down at times (before and after 2008) when letting deficits widen beyond 3% of GDP was the only way to keep their economies growing. Without such growth, public debts rarely fall in relation to GDP.
In reassuring contrast, the UK’s new charter leaves future chancellors much scope for running wider deficits without breaking the rules. Financial markets would be worried were it not so. The polite fiction of de-politicised monetary policy, via central bank independence, was rightly discarded when finance ministers and bankers lined up together to combat the crash of 2007-8. Depriving policymakers of fiscal discretion is an even more dangerous idea, unless we suddenly enter a world with no unforeseen shocks. Balanced-budget laws have never lasted. Luckily, the UK’s new charter doesn’t even pretend to be one.