Unlock the Editor\u2019s Digest for free<\/p>\n
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.<\/p>\n
The writer, an FT contributing editor, is a former chief economist at the Bank of England<\/p>\n
Well-designed fiscal frameworks are the cornerstone of macroeconomic success. By anchoring expectations for government borrowing, they lower uncertainty and economy-wide borrowing costs. They also support growth, by cushioning or countering adverse shocks to the economy and enabling public investment.<\/p>\n
On these criteria, the UK\u2019s fiscal framework fares poorly, more millstone than cornerstone. As currently designed, it is amplifying rather than reducing uncertainty about fiscal policy. It is an inhibitor, not enabler, of growth. Unless it is reformed fundamentally in November\u2019s Budget, prospects for UK growth \u2014 and this government \u2014 are unlikely to improve.<\/p>\n
The optimal framework for macroeconomic policy involves combining elements of both rules and discretion \u2014 \u201cconstrained discretion\u201d. The \u201crules\u201d element, often the focus of attention, is important for providing clarity and a degree of pre-commitment to ensuring policies are sustainable. That matters for credibility, not least in the eyes of bond markets.<\/p>\n
But the \u201cdiscretion\u201d element is important for credibility too. It allows governments to act as a shock absorber, responding countercyclically to protect growth and jobs following adverse events. That flexibility has proved crucial. Among G7 countries, fiscal support averaged 5-10 per cent of GDP during the Global Financial Crisis and 15-20 per cent during Covid. <\/p>\n
Ironically, policy frameworks of the past have often foundered on the rocks of inflexibility. It was the fear of policy cratering, rather than cushioning, the economy that caused the UK to abandon the Gold Standard, monetary targets and the Exchange Rate Mechanism. The \u201cironclad\u201d nature of these rules was the very thing that made policy leaden-footed and tin-eared when growth soured. This fate now awaits the current ironclad fiscal framework.<\/p>\n
Like inflation targets for monetary policy, fiscal rules are set in the expectation of being hit at some future point. And as with inflation forecasts, the uncertainty around projections of the fiscal position is large. As the Office for Budget Responsibility makes clear, this uncertainty amounts to several percentage points of GDP at a five-year horizon and much more at the longer horizons relevant to judging debt sustainability.<\/p>\n