Must-read: Simon Wren-Lewis: “A (Much) Better Fiscal Rule”

Must-Read: Simon Wren-Lewis: A (Much) Better Fiscal Rule: “Today the Labour Shadow Chancellor John McDonnell…

…will give a speech where he puts forward an alternative fiscal rule… a rolling target for the government’s current balance: within 5 years taxes must cover current spending. It leaves the government free to borrow to invest…. There is a commitment to reduce debt relative to trend GDP over the course of a parliament. No doubt we will hear the usual cries from the opponents of sensible fiscal rules: Labour plan to borrow billions more than George Osborne and they plan to go on borrowing forever. The simple response to that should be that it is right to borrow to invest in the country’s future, just as firms borrow to invest in capital and individuals borrow to invest in a house. Indeed, with so many good projects for the government to choose from, and with interest rates at virtually zero, it is absolute madness not to investment substantially in the coming years….

Recessions come and go, you might respond, but higher debt will always be with us. That ignores two key points. First, prolonged and deep recessions cause lasting damage. UK GDP per head is currently over 15% below pre-recession trends. Does none of that have anything to do with the slowest UK recovery from a recession in centuries? Second using fiscal policy to end recessions quickly does not mean higher debt forever. The key point is that debt can be reduced once the recession is over and interest rates are safely above their lower bound. Doing that will be no cost to the economy as a whole, as monetary policy can offset the impact on demand. Obsessing about debt during a recession, by contrast, costs jobs and reduces incomes, as every economics student knows and as the OBR have shown….

Some Labour MPs and commentators. They say, quite rightly, that one of the main reasons the 2015 election was lost was because Labour were not trusted on fiscal policy. But the basic truth is that you do not enhance your fiscal credibility by signing up to a stupid fiscal rule. Apart from getting attacked for doing so by people like me, your collective heart is not really in it and it shows. You get trapped into proposing to shrink the state as Osborne is doing, or hitting the poor as Osborne is doing, or raising taxes which makes you unpopular. And if by chance it ever looks like you might be getting that trust back, Osborne or his successor will move the goalposts again.

The far more convincing way to get trust back is to adopt a fiscal rule that makes sense to both economists and the public (‘only borrowing to invest’), and actively talking about it….

The Conservatives know they are vulnerable on public investment. Osborne tries to give the impression that he is doing a lot of it, but the figures do not lie. In the last five years of the Labour government the average share of net public investment in GDP was over 2.5%. During the coalition years it fell to 2.2%, and for the five years from 2015 it is planned to average just 1.6%. That is not building for the future, but putting it in jeopardy, as those whose homes have been flooded have found to their cost.


Brad DeLong


Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch