Winner of the New Statesman SPERI Prize in Political Economy 2016

Saturday 26 March 2016

Fiscal rule redux

Although this discussion is about the UK, the macroeconomic issues involved apply equally elsewhere.

Most of the media discussion of Labour’s new fiscal rule presented before the budget focused on the commitment to balance the current budget. The media did this because ‘the hook’’ was the similarity between this aspect of the rule and the rules proposed by Brown or Balls. As I noted at the time, no one in the media seemed to want to compare this goal to the Chancellor’s overall surplus objective, which remains rather extraordinary.

In some ways this element is the least interesting part of the rule. Two other key parts are that current balance is a rolling five year target, and the knockout if interest rates hit their zero lower bound (ZLB). Both are more difficult to explain quickly in a mediamacro world where the deficit is considered all important, although at least with the rolling 5 year target a quick response is that the coalition government adopted exactly that form of target. If they had adopted the less flexible target of current balance by 2015, the economy would have been even more screwed by austerity than it actually was.

The really new feature of the rule is the knock out. (This was described as a ‘loophole’ by one political reporter: mediamacro again.) The rule is deliberately suspended to allow for fiscal stimulus when interest rates hit their ZLB. How much stimulus? Whatever it takes to get interest rates to rise above the ZLB. In Portes and Wren-Lewis we suggest the Bank of England are the obvious people to advise on this (the size of stimulus, not its form in terms of spending increases or tax cuts). The focus of fiscal policy switches from deficit control to stabilising demand, but only because monetary policy can no longer do that job effectively.

If such a rule had been in operation during the Great Recession, we would have seen a continuation of the fiscal stimulus we saw in 2009 into later years. That would have meant, for sure, that government debt would have risen by more than it did, but it would also have meant, for sure, that output would have recovered more quickly. What would have happened to the debt to GDP ratio we cannot know for sure, but the important point is that this does not matter.

It is this last point which is the most difficult to convince people about in the mediamacro world. In this (imaginary) world, we have to worry about the deficit because if we do not there might be a financial panic, with interest rates on government debt rising and perhaps even an inability to sell that debt. The best response to this concern is it would not matter even if it happened, because the Bank of England would buy the debt and keep interest rates on that debt down. Of course the market panic scenario will not happen anyway, because there is zero chance that the government will default, but trying to convince people that the financial markets will behave rationally after the global crisis is hard.

Many non-economists think creating money to cover the deficit sounds outlandish, until you point out it is already happening with QE. The potential size of the QE programme is unlimited. The whole point of QE is to keep long term interest rates, like the interest rate on government debt, low. QE happens when short interest rates are at their ZLB. That it why, when rates are at the ZLB, fiscal policy can focus on stimulating the economy. [1]

There are some who think that any kind of fiscal rule represents appeasement of the austerity position. As I discussed in my post on MMT, I do not think that is very good economics, particularly for a party (like Labour) that is committed to maintaining an independent central bank that uses monetary policy to stabilise demand. In that regime, when you are not at the ZLB, deficit bias is a potential problem. I think intergenerational fairness is important, and we shouldn’t ignore it just because the argument is misused to support austerity. I am reminded of this every time I look at Norway, and recall how Mrs. Thatcher effectively used oil revenues to cut taxes rather than build up a sovereign wealth fund. There is a certain irony that George Osborne’s current policy of going for surplus, while totally wrong for today, would have been the right policy in the late 80s and 1990s.

Ellie Mae O'Hagan recalls how many on the left (in my recollection all shades of the left) argued that when austerity started to bite there would be a popular revolt against the policy. That did not happen, in part because of mediamacro, but also because there was not a clear alternative to unite behind. Labour tried to have it both ways, expressing worries about what austerity was doing but also agreeing that the deficit was a current concern. In Labour’s new fiscal rule we have a policy that sets out clearly how we should deal with any new crisis, and also how we should have dealt with the last one. It is a policy the left should unite behind, because overcoming mediamacro’s obsession with deficits will not be easy.

[1] You can only do this if the government controls the currency its debt is issued in. When that does not happen, as many developing countries have found to their cost, you do have to worry about the bond markets. That was exactly the problem that led to the Eurozone crisis, until the ECB came up with OMT.
A more elaborate argument for countries that do borrow in their own currencies is that a market panic over government debt would be accompanied by a run on the currency. Paul Krugman tackles this, but following discussions with the FTs Martin Sandbu I do plan to discuss this issue further at some point.  


  1. "recall how Mrs. Thatcher effectively used oil revenues to cut taxes rather than build up a sovereign wealth fund."

    No and neither does anybody else. Implicit fixed exchange thinking in that statement. What else were you expecting oil workers to be doing other than working on oil extraction and refinement?

    You seem to be seriously struggling with the idea that you look at what people and stuff you have, what you want to get done and then the money and tax positions just follow from that process.

    1. So you think Norway did the wrong thing and Mrs. T had it right.

    2. Mrs T didn't get it right but the Norwegian thinking is flawed.

      My view - leave the oil in the ground and redeploy the Norwegians to writing poetry. Or buy other stuff from abroad.

      There is nothing that says you have to suck as much oil out of the ground as you possibly can every day - other than the madness of the market and virtue signalling by macro-economists :)

      Firstly taxes do not fund anything. It is important to separate this from export led growth. The government does not need taxes to buy foreign currency and pursue 'export-led growth.'

      Sovereign Wealth funds are centralised hoarding of foreign financial instruments. You've essentially swapped your real output for a financial claim on a foreign entities which it may or may not fulfil in the future. Earning numbers doesn't help your population eat.

      Generally you only want to give away real output to the extent that you need foreign goods and services. Otherwise you're using real capacity today for no benefit to your citizens today.

      A lot of these sovereign wealth funds are just ways by which the central bank injects its own money into the economy. If you 'swap' central bank created money for, say, US dollars it doesn't look like you're deficit spending. Of course you are because the population is saving your local currency and the central bank is just saving a matched foreign currency instrument and pretending those are equal.

      Next week you'll have to issue some more local currency.

      The Norwegian system works like that - as Bill Mitchell describes in Myths regarding sovereign funds

    3. Doesn't a sovereign wealth fund simply increase the proportion of future goods and services that may be consumed by future generations of Norwegians, at the expense of future generations of non-Norwegians? I don't understand how Norway's building up such a fund substantially differs from Germany's present insistence on running a surplus. I can think of two objections to the Thatcher tax cuts. The first is that the conditions at the time may have been right for the government to do fiscal consolidation (I don't know, not being an expert, but the sentence in the post that follows the one being discussed here certainly seems to imply that this was the case). The second is that the tax cuts were regressive. In this latter case the argument concerns, surely, the most appropriate level of taxation, the level that best acheives fairness of distribution without overly compromising production. I can't really see how either of these objections is to do with intergenerational fairness. Certainly, I can see that intergenerational fairness might have been served by leaving the oil under the sea, rather than consuming a finite resource and causing considerable environmental damage in the process, but that is not, I think, what the Norwegians did.

  2. "As I discussed in my post on MMT, I do not think that is very good economics, particularly for a party (like Labour) that is committed to maintaining an independent central bank that uses monetary policy to stabilise demand."

    Hmm. I disgaree. We need to use auto-stabilisers (fiscal policy.)

    Firstly is no lag when the DWP does it. Pensions, tax credits, benefits and ancillaries scale automatically based upon requirements, and they scale back automatically as people earn more income. That's the whole point of having the RTI system in Universal Credit. It is part of the auto-stabiliser system that has worked perfectly since Keynes' day.

    And importantly for me the Bank of England can't do anything about full employment.

    To have full employment you have to have enough jobs. To have enough jobs somebody has to create those jobs. The private sector won't - at least if you want it to be productive, so the public sector has to.

    It's not the Bank of England that has to prioritise full employment. It's the Department of Work and Pensions.

    There is no magic in the Bank of England. It's just a bank. It's the democratically elected government's job to create jobs.

    Classically schooled journo economists are already calling 'full employment' in the UK and have been for about a year. So the current values can be taken as mainstream NAIRU values (correct me on this Simon.)

    Those are 1.685 million people 'ILO unemployed', 2.214 million people 'inactive - wants a job' (not 'unemployed' because they are not 'actively searching'), and 1.209 million 'Part time want Full time' (again not 'unemployed' because they've found a bit of something).

    In addition there a 1.162 million people in second jobs.

    So those without work that want it is 3.899 million people.

    To put that in context those without work is about half the population of London, or alternatively more than the population of the 2nd to 7th biggest cities in the UK - Birmingham, Leeds, Glasgow, Sheffield, Bradford and Liverpool.

    Those short of work that want more work (including the part-timers) is 5.108 million, and those short of decent quality work (including the second job people) is about 6.27 million.

    Labour should put full employment via Job Guarantee at the heart of its economic policy to neutralise the benefits debate. Plus one in three workers are in the wrong job:

    1. On ‘Labour should put full employment via Job Guarantee at the heart of its economic policy to neutralise the benefits debate’, I’ve commented before on my doubts about a JG scheme being able to handle 5-6 million people but I decided to do some searching on this.

      The most worked though proposal I have found is a report from Bill Mitchell’s CFEE on ‘creating effective local labour markets’ in Australia (
      Given its lead author, I guess many supporters of MMT are aware of this report, although I also guess that at 300 pages few have read it all. I’m not claiming to have done so either but much is repetitive or detailed and the essence can be gleaned from a few sections.

      Of particular interest to me was section 10 outlining a strategic framework for regional development. The strategy has three elements: public sector and macroeconomic expansion targeted at employment, infrastructure and services; a comprehensive skills framework; and a JG scheme. So JG is here presented not as the whole solution but as the third of a set of proposals, which is much more plausible than how its UK advocates often present it.

      As regards Labour policy, the first two elements were already advocated during Jeremy Corbyn’s campaign through a National Investment Bank and a National Education Service. Quite a bit of work has been done since on the investment side, although less so far on skills. There is no specific proposal on a JG but the intention would be radically to reduce unemployment and underemployment through the first two points. As I have stated before, I can see scope for a guarantee of work at the margins of the employment market but this is not yet policy.

      Intriguingly, although MMT is discussed extensively in the report, the framework in section 10 is justified by ‘spatial Keynesianism’. This is a useful reminder that practical proposals on investment, employment and skills need not depend on theoretical agreement. It’s important that where we agree on specific policy steps, such as the current need for investment-led fiscal expansion despite the immediate impact on deficits, then we should campaign for that without letting theoretical divergences divide us.

      A JG scheme is the topic of section 13. Inflation control is discussed and it is recognised that fiscal authorities would need to reign in any private wage-price pressures, although some assumptions around the behaviour of private employers and the responsiveness of the education sector feel a little hopeful. There is also a long discussion of implementation issues: I was not entirely convinced by all the answers but it was good to see these getting serious attention. The smaller we can keep a specific JG scheme by putting most emphasis on investment and skills development, the easier it will be to manage.

      Hope this is helpful.

  3. Would you and the rest of the advisory committee support a fiscal rule where fiscal stimulus at the zero lower bound was always funded by new printed money? What are the arguments against this: inflation is unlikely at the ZLB and when maintaining the ICB the timing can be kept sensible.

    There more interesting question, however, it what comes next. Say interest rates are sitting at 3% two years from now and the BoE feels that there are sufficient deflationary that would normally require that they lower rates.

    In such a case would it not be better that demand is held up by means of a stimulus (from printed money) rather than by lower rates? there would be no need to inflated domestic debt and the government could devote the money to achieve more worthy social goals.

    1. Money financing: no arguments against, and it may happen anyway. The only advantage of doing that is that you take worries about issuing debt seriously.

      When the central bank lower interest rates they are creating money.

    2. They are both "creating money" but the monetary and the fiscal versions (lowering raters or helicopter type) have very different effects. Which do you think is better and why?

    3. At the ZLB, short term nominal rates are fixed, by definition. So your question is really whether we should have QE as well as a fiscal stimulus at the ZLB. Not clear why we need QE, when fiscal stimulus is a better instrument.

    4. But what I asking is why ,when NOT at ZLB, you would prefer the lower of interest rates to a helicopter drop?

  4. I have 2 concerns about Labours new fiscal rule:
    1. It does not challenge the deficit obsessio or govt as household metaphor, indeed it reinforces it, especially when presented as Labour will balance the books'
    2. How do we know balancing current spending is always the right policy? E.g Suppose we need more nurses more than road improvements?

    1. 1. As long as monetary policy is managing demand, you need a debt or deficit based fiscal rule. Refusing to have one will convince no one.

      2. There is no 'right' policy. But deciding on the best policy on the deficit should not be influenced by whether we need more nurses. If we put more resources into the NHS, we have to decide what we put less (public or private) resources into.

    2. 1. Please could you spell out why this is the case as it is not obvious (to me at least)

      2. My point is that at times some current spending may be more important that some investment projects, at which point a rule that insists on balancing current spending becomes a straightjacket. The rule about reducing debt to tend gdp will guard against overspending so why do we also need the current balance rule, which IMO leads to renewed focus on the'balancing the books' nonsense.

    3. 1. What stops deficit bias (e.g. governments cutting taxes or spending more using debt finance for political reasons) when monetary policy will stop any consequent inflation?

      2. I do not see why a rule that says debt must fall relative to trend GDP avoids a focus on deficits?

    4. 1. Wouldn't most governments want to avoid the distributional or political consequences of high interest rates? And is there not a limit to how far the cb could use interest rates to offset excessive government spending without inducing recession? A responsible government does not need to tie it's own hands with arbitrary rules. An irresponsible government will not be bound by them anyway.

    5. 2. You're right it doesn't. And the media will probably regard it as another loophole if they ever catch on to its meaning.

    6. "when monetary policy will stop any consequent inflation?"

      Perhaps. Monetary policy is a blunt tool.

  5. Intergenertional fairness is a great idea. Can we have it?
    Public debt can not change intergenerational distrbution, nor it should be an excuse that you are attemptng to control it, because that is impossible.

    First reason that pubic debt is not affecting intergenerational distribution is that debt is never payd down by any generation. That is why 88% of the time in the past 100 years there was primary deficit.

    If only 12% of the time there is primary surplus, then who is ever paying debt down, what generation?
    Since every generation is accumulating more savings that provide funds for deficit, debt is never payed down, nor it is good to be lowered as savings grow.

    Only private savings can affect intergenerational distribution which is what your explanation shows, not public debt.

  6. And what are those countries that borrow only in their own currency?
    British Commonwealth countries, USA, Japan, Switzerland. That is itEveryone else have to import with foreign currency.

    LOOK there all are former empires. So, that is how colonializm is still alive; force other countries to borrow your currency to import from you while you import in your own only.
    Colonializm is still allive but by other more subtler means.
    They have to keep borrowing from you in order to refinance old debts.

  7. The problem with this as I see it is that it is not comprehensible to the average voter; it may be correct and justifiable in economics but they won't understand it and mediamacro will dismiss it as gobbledegook and little more than an excuse to spend more. You clearly don't like it but the mediamacro view is far more comprehensible, albeit less sensible in economic terms.

    Now you could argue that it's the job of politicians to make the subtle understandable and to exercise the arts of persuasion but I suspect that would be somewhat difficult.

    1. Are you saying that in the UK today it is impossible to implement policies based on basic economics?

    2. Of course not but what you and I might call "basic economics" is not what the average voter calls it and it is the average voter that we are talking about.The fact that economically illiterate arguments persist - which you regularly highlight here - shows that this view is correct as much as you, and I for that matter, may lament it.

    3. On the evidence of the last 6 years, the answer would appear to be 'yes'!
      Your fiscal rule may well be the best available under current institutional arrangements, but it is subtle, so convincing the media and the public is a major challenge. I applaud your efforts though and urge you to keep going. If you could convince more people in the Labour Party outside of the leadership ((Eg Ummuna, Reeve etc) they could probably sell it more effectively than Mcdonnell alone. Are there any plans for the EAC to engage with the wider Labour group?

    4. Robert: What I'm trying to get at is where this leads you? That politicians should pursue bad economics, or that they have to?

      Anon: On your last suggestion, I would love to discuss this with other Labour Party MPs.

    5. 'I would love to discuss this with other Labour Party MPs'

      great - what's stopping you then?

    6. Could you not approach them? Surely they would be prepared to listen to an offer of help from an Oxford professor of economics who has spent the past year attacking their opponents policies and coming up with ideas for alternatives?

  8. I suggest we just cut all the cr*p and accept Keynes's dictum: "Look after unemployment and the budget looks after itself". MMTers fully agree with that dictum.

    Dimwitted as politicians are, is it really all that difficult to explain that to them? I mean give me ten minutes and I could even explain it to bumbling buffoon Boris Johnson.

    1. I think Boris will tell you we have created record levels of employment by fixing the deficit problem.

  9. This so-called fiscal rule is actually a just a target for debt and the current balance. So why not instead target more meaningful variables such as inflation, unemployment,underemploymebt & gdp, together with a credible process for achieving them? E.g:
    1. Government makes provisional tax & spending proposals, submits these to Bank of England
    2. Bank sets interest rate path to achieve inflation target
    3. OBR forecasts gdp, unemployment
    4. Government adjusts plans
    5. Iterate 1-4 until targets line up
    6. Repeat 1-5 twice a year or following a shock.

    1. You want to change what I call the consensus assignment, and have the government using fiscal policy to manage demand at all times. So you need to explain why that would be better, and why governments across the world rejected that approach 40 years ago.

    2. Not necessarily, I have no problem with using monetary policy in conjunction with fiscal policy depending on circumstances, why does it have to be always one or the other? Eg in my example above govt might decide to accept an interest rate rise or reduce spending or raise taxes. Of course politics will affect their decision but that's what happens in democracies and if they mess up they will be punished by the voters. I guess I am arguing against independent cb which just lets the govt off the hook.

  10. Certainly agree that Labour should unite behind their leaders and that any MPs who remotely support austerity should be ashamed of themselves - and obviously your argument is that the new current Labour Party policy is different but not too overly radical for the mostly neoliberal Labour Party MPs.
    I wonder though if they shouldn't instead just be telling the electorate and the rest of the Labour Party exactly whose money Sterling is and how it is created and what they think the economy is for. It would come as a shock to the overwhelming majority. Maybe like that they'd get more media coverage and put more pressure on the Tories...
    And also they need to tell local authorites to set up banks. That way local authorities could build social housing without reference to Osborne, and to a certain extent beat Neoliberalism at its own game. Even more so as local authority income from government is going to reduce to nothing in the next years and not even many Tory councils are happy about that..

  11. Osbourne's issues with further cuts, are a revolt of a kind.
    I had an alternative view, but Ed Balls was chancellor. And I am nobody.

    This is a dramatic reversal of direction. At a ZLB, Q.E. was the answer! or Negative Interest rates.

    Many may not be prepared to engage in the necessary level of stimulus, including the Bank of England, as you noted, the world is full of deficit hawks, and you have already created 345Bn in the form of failed Q.E, with it's undesirable distributional effects...

    An issue (IMHO) MMT addresses better than your fiscal rule.

  12. Further thoughts...

    The political reporter was right, you have just added a loophole or panic button to your previous rules, which appears arbitrary and inconsistent.

    Hard money until the banks crash the economy and then soft money to bail out the economy, including fiscal policy which was previously heavily constrained.

    As for inter-generational fairness, you can only divide the economic pie in the present.

    A surplus was not the right policy in the 1980's and is not now, a deficit bias is the correct bias, see sectorial balances.

    MMT is consistent, while your proposed policy is riven with contradictions and intellectually unsatisfactory.

  13. I struggle with the intergenerational fairness concern, often framed as intergenerational theft, assuming we are not talking about reductio ad absurdum propositions.

    To me, debt servicing ability is of utmost importance, therefore investment that is funded by borrowing needs to deliver reasonable returns, but I wouldn't make too much of this, given the very long term nature of most state investments. Even counter cyclical borrowing during a slump for consumption can be prudent and sensible, as it avoids hysteresis effects.

    In the long term, governments can generally just let the debt dwindle as a percentage of GDP (as a result of the combination of GDP growth and inflation) in the good times. A good example is New Zealand in the 2000s. We all say that government 'paid down debt' when in reality it just didn't increase it, and we were well situated for the GFC (and a couple of hefty earthquakes) as a consequence.

    Naturally, our analysis would change if r > g.

    But this topic comes up a lot, and I'm very interested in exactly what you would propose as representative of intergenerational unfairness, or whether you largely agree with my points.

    1. On the theory of intergenerational fairness, read my or Nick Rowe's posts on the subject. A good example of intergenerational theft was how the UK spent North Sea Oil revenues (compare with Norway).

    2. "A good example of intergenerational theft was how the UK spent North Sea Oil revenues (compare with Norway)."

      The UK government can cut taxes or increase spending if there are resources free regardless of North Sea oil.

      Why would the 'export-led growth' nations who export to the UK want the pound to depreciate? What possible advantages are there to a trade war?

      The 'mug' countries can indeed sometimes introduce export led growth and depress living standards in the short term. But generally that is a bad idea.

      SWF suffer from fallacy of composition and enforce global deflation, harming fellow humans in foreign countries.

      And this has *nothing* to do with the other things you have been saying on 'intergenerational fairness.' That has all been about the national debt. It is just using a popular myth as a smokescreen.

      It is pretty sick that economists who deliberately create *forced* unemployment - youth unemployment is above 12% at 'full employment' - still push this crap. You are no friend of young people.

    3. Norway has less than one tenth the population of the UK, and to date, has earned over $700 billion more from oil and gas production.

  14. I've already given a more complete critique in your MMT post, but I think one of the underlying issues is that the terms of the "mediamacro" debate are still set by mainstream macroeconomics. Yes, sensible economists are clearly on the correct side of the mediamacro debate while the media is not, but it is the economists who are to blame for the misleading notion that a government "borrows" in its own currency.

  15. So, the idea of a fiscal rule seems reasonable, but I think it would make much more sense to target a long-term structural deficit of, say, 2% rather than targeting a balanced budget.

    It seems to me that the rhetorical bias towards a long-term balanced budget (or worse, a surplus) is actually one of the causes for current economic woes.

    Rather than having exceptions for the budget balancing rule in the ZLB case, why not just target a sustainable (2%-ish) structural deficit so as to make ZLB-type problems less likely in the first place?


Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time. In addition, I cannot publish comments with links to websites because it takes too much time to check whether these sites are legitimate.