Economists were unanimous after Sajid Javid’s spending review on Wednesday: The chancellor’s fiscal rules were dead and Boris Johnson’s government, much like that of Donald Trump in the US, no longer cared much about budget deficits.
So much for the mantra of Gordon Brown, Labour’s chancellor for the decade after 1997 who introduced fiscal rules to the UK in the name of “prudence”.
Mr Javid said his spending review met the government’s existing fiscal rules but he would review the entire framework in time for an autumn budget.
Oxford Economics said Mr Javid’s generous public spending settlement could not be met within the current deficit limit of 2 per cent of national income nor the rule to keep the public debt burden falling “Those targets look set to join the long list of abandoned fiscal rules,” said Martin Beck, lead UK economist at Oxford Economics.
However, since 1997 other chancellors have discarded the fiscal rules by necessity in an economic downturn, while Mr Javid has chosen to loosen the fiscal framework by design.
Torsten Bell, director of the Resolution Foundation, said: “The chancellor has binned both austerity and his fiscal rules, bringing down the curtain on the era of public spending constraint in spectacular fashion”.
Simon Wren-Lewis, professor of economics at Oxford university and the inspiration behind part of the Labour Party’s own fiscal credibility rule, said, “[the new Tory position] is a complete change from the previous idea that you’ve got to get [debt] down”.
These assessments did not come from a Treasury document, but were inferences from the chancellor’s big increases in day-to-day public spending and hints there was much more to come on capital spending.
With 13 mentions of infrastructure in a relatively short speech, the Mr Javid left little to the imagination on borrowing and debt. “We’ll settle for nothing less than an infrastructure revolution,” he said pointing to the ease with which the government could finance borrowing. With a “record low cost of borrowing, we can invest more in growing our economy,” he added.
Limits to his borrowing and debt spree would be set out in a new fiscal framework in the Budget, the chancellor said, and Treasury officials have been instructed to expect big numbers and say the prime minister had “mis-spoken” when he said at the weekend that the Tories would continue in future “to keep debt falling every year”.
Borrowing is already rising compared with last year and the debt ratio has only just started falling as a share of national income, after it exploded during the financial crisis a decade ago.
Mr Javid’s U-turn fits with the fashion in economic circles this year. Christine Lagarde, the former head of the IMF and soon to be president of the European Central Bank, also called on eurozone countries to launch a fiscal stimulus on Wednesday.
And these moves are anchored in the January presidential address to the American Economics Association by Olivier Blanchard, the former chief economist of the IMF. He said that countries could take advantage of low interest rates to issue more debt without necessarily having to raise taxes to pay for it in future.
Since Labour is unlikely to run an election campaign on Tory profligacy, the question for Mr Javid or John McDonnell, shadow chancellor, is what fiscal constraints are sensible if the current rules are no longer worth the paper they are written on.
One of the simplest rules would be to stop debt rising as a share of national income in normal times. On most UK economic forecasts, this would allow borrowing of roughly 2.5 per cent of gross domestic product a year — or around £55bn a year, compared with the current forecast by Office for Budget Responsibility, the fiscal watchdog, of £29bn for 2019-20.
That means the chancellor has leeway of about £21bn-£25bn a year to increase borrowing and keep debt stable, according to the OBR, but Mr Javid spent £13.4bn of that leeway on Wednesday and clearly wants to spend more in future.
Since economists do not know the right level of debt for an economy, an alternative might be to set a new ceiling, of for example 100 per cent of GDP — compared with the current level of 82 per cent — allowing much more spending and lower taxes until the ceiling is reached.
Failing that, Mr Javid will be tempted, given his focus on infrastructure, to have a borrowing rule that excludes capital spending. If he set a limit on current borrowing of 2 per cent of GDP, meaning that debt was allowed to accumulate if it was backed by an asset, he would have many tens of billions a year to play with.
Economists tend to be sceptical of such suggestions. Professor Wren Lewis, a noted academic on the left of politics, said, “I don’t think I’d be happy seeing a steady rise in the debt-to-GDP ratio”.
Jagjit Chadha, director of the National Institute of Economic and Social Research, wrote recently of concerns about assuming interest rates would remain low for ever. Worrying about future generations that would have to service any new debt, he said, “it may be misleading to use the temporary [low] costs of funding to demand higher debt levels”.
Apart from these economists’ concerns, Mr Javid has a big political dilemma. The only time the Conservatives have won a majority in Parliament since 1992 was in 2015 and that election was won almost entirely on the back of a message on prudence in the public finances.
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