In the run-up to the recent General Election, the Conservative Party announced that it would legislate to ban increases in income tax, VAT and national insurance over the course of this parliament. The new government is now announcing that it intends also to legislate so that governments, during ‘normal’ times, must balance their budget.
To stipulate that, over the course of an economic cycle, the government should (at least approximately) balance the budget is not controversial. Gordon Brown introduced the ‘golden rule’ for fiscal stability in the 1998 Finance Act - though he subsequently demonstrated that such rules can be finessed. What is new about George Osborne’s plan is that a lock on borrowing now accompanies a lock on taxation. The co-existence of both locks implies that the government will retain no discretion to vary government expenditure.
Fiscal policy will thus be locked. With interest rates at the zero lower bound, abstracting from unconventional measures, monetary policy is – for the time being – locked too. Hence the whole of demand management policy is locked. Subject to interpretation of the word ‘normally’ (and what a wonderful word that is), the Chancellor has wrapped himself and the rest of the country in chains. Mr Osborne is, normally, a very astute politician – this may be smart politics, putting the opposition on the back foot. But, normally, it is also rash economics.
For a wise Chancellor keeps his or her options open. And that is where the interpretation of ‘normally’ comes back in. The years around 2007-09 were not, by any stretch of the imagination, normal. The lock on the government budget would not have applied then, and would not have saved the UK from the accumulation of a large fiscal burden. Quite right too – the desperate nature of the period called for action using all available policy levers.
One might hope that the Chancellor and his successors will be able to tell the difference between what is normal and what is not. For at least a couple of years before the financial crisis, Gordon Brown demonstrated that the problem with Chancellors is that they are human; they suffer from human nature and believe the hype that suits them. Rules have the benefit of offering the rest of us some protection from this, but at the end of the day there are times when such rules ought to be broken, and that inevitably involves a call of human judgement.
At best, the lock on demand management policy is not sensible – a rule that can be broken at will. At worst, it could seriously harm the ability of the government to respond appropriately to what Harold Macmillan called ‘events, my dear boy, events’ – and in this eventuality it would look like foolishness.
And at any point in between, the policy lock could have adverse implications for economic growth and employment. It should be remembered that these, not the deficit, are the legitimate objectives of policy, and that the regulation of borrowing should be but a means to meeting those ends.
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