© Institute for Fiscal Studies Fiscal (in)discipline: the UK experience Robert Chote International...

© Institute for Fiscal Studies

Fiscal (in)discipline: the UK experience

Robert Chote

International Monetary Fund, 2 June 2009


Outline

• Gordon Brown’s 1997 fiscal framework

• The fiscal rules: met or missed?

• The credibility of the rules pre-crisis

• The post-crisis framework

• Opposition plans for a fiscal council

• Would that have helped in the past?

• Role and design of proposed fiscal council

• Final thoughts


Gordon Brown laments his fiscal inheritance

“On arrival in office in 1997 the Government was faced with a large structural fiscal deficit, low net investment, rising public debt and falling public sector net worth. Urgent action was needed.

This situation had come about in part as a result of a lack of clear and transparent fiscal objectives.”

HM Treasury, Analysing UK Fiscal Policy, November 1999

http://www.hm-treasury.gov.uk/d/anfiscalp99.pdf


The response: a new fiscal framework

• “Code for Fiscal Stability”: broad principles enshrined in legislation

• Golden rule

– only borrow to invest

– surplus or balance on current budget

– on average over economic cycle, not every year

• Sustainable investment rule

– keep debt at a “stable and prudent” level

– defined as below 40% of national income

– to be met every year in current economic cycle

• Limited (but oversold) independent auditing of forecast assumptions

• Treasury dates cycle itself by identifying on-trend points


The fiscal rules: outturns and prospects

• Over Treasury-defined cycle from 1997–98 to 2006–07:

– Golden rule met with £2bn (0.14% of GDP) a year to spare

– Sustainable investment rule met with 4% of GDP to spare

• Treasury forecasts imply that both rules set to be missed by huge margin over cycle beginning in 2006–07 (which we assume to end in 2015–16)


Golden rule: public sector current balance

-10

-8

-6

-4

-2

0

2

4

Perc

ent of

nat

iona

l inc

ome

Budget forecastOutturnsAverage for cycle


Sustainable investment rule: public sector net debt

0

20

40

60

80

10019

75-7

6

1980

-81

1985

-86

1990

-91

1995

-96

2000

-01

2005

-06

2010

-11

2015

-16

2020

-21

2025

-26

2030

-31

2035

-36

2040

-41

Perc

enta

ge o

f nati

onal

inco

me IFS extrapolation

Budget forecast

Outturns

40% ceiling

Note: Excludes unrealised losses on financial interventions.Sources: HM Treasury; IFS calculations.


Fiscal rules had lost credibility pre-crisis

• “Almost none use the Chancellor’s fiscal rules any more as an indication of the health of the public finances” (Financial Times survey of independent economists, January 2007)

• At the end of Labour’s first term (2001) it looked as though the rules would be met by huge margin, even with spending growing rapidly

• ‘Conviction forecasting’ – no possibility of breach entertained

• But HMT repeatedly underestimated revenue decline after dotcom bubble burst and overestimated speed of revenue recovery

Serially overoptimistic current budget forecasts

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99–0

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% o

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com

e

Budget 01

Budget 02

Budget 03

Budget 04

Budget 05

Budget 06

Budget 07

Budget 08


Fiscal rules had lost credibility pre-crisis

• “Almost none use the Chancellor’s fiscal rules any more as an indication of the health of the public finances” (Financial Times survey of independent economists, January 2007)

• At the end of Labour’s first term (2001) it looked as though the rules would be met by huge margin, even with spending growing rapidly

• ‘Conviction forecasting’ – no possibility of breach entertained

• But HMT repeatedly underestimated revenue decline after dotcom bubble burst and overestimated speed of revenue recovery

• As margin eroded, concerns that HMT was moving the goalposts: changing balance measure, redating cycle to add extra surpluses

• Independent forecasters’ scepticism rubbished

• Need to tighten denied up to 2005 election campaign, but tax increases and cuts in spending plans followed at next opportunity

• Rules failed to take politics out of the Budget

The post-crisis framework

• “Temporary operating rule” announced in November 2008:

“To set policies to improve the cyclically-adjusted current budget each year, once the economy emerges from the downturn, so it reaches balance and debt is falling as a proportion of GDP once the global shocks have worked their way through the economy in full.”

• Even vaguer than previous formulation – no move to IFA or FC

• HMT has been praised for realism of assessment of structural fiscal problem (although obscure to public)


The problem: more borrowing, mostly structural Public sector net borrowing in Budget 2009, excluding PBR and Budget policy measures

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-12

-10

-8

-6

-4

-2

020

08-0

9

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

2016

-17

2017

-18

Perc

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Extra cyclical borrowingExtra structural borrowingBorrowing in Budget 2008

Sources: HM Treasury; IFS calculations; figures may not add due to rounding.



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08-0

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2009

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2010

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2011

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2012

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2013

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2014

-15

2015

-16

2016

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2017

-18

Perc

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ome





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020

08-0

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2009

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2010

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2011

-12

2012

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2013

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2014

-15

2015

-16

2016

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2017

-18

Perc

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The post-crisis framework

• “Temporary operating rule” announced in November 2008:

“To set policies to improve the cyclically-adjusted current budget each year, once the economy emerges from the downturn, so it reaches balance and debt is falling as a proportion of GDP once the global shocks have worked their way through the economy in full.”

• Even vaguer than previous formulation – no move to IFA or FC

• HMT has been praised for realism of assessment of structural fiscal problem (although obscure to public)

• Criticised for over-optimistic GDP forecasts

• And for lack of clarity in consolidation plan – scale, speed and composition all up for grabs given election timetable


Two parliaments of pain: taxes or spending?

Sources: HM Treasury; IFS calculations.

Opposition now propose “fiscal council”

• Office of Budget Responsibility

– Responsible to Parliament

– Small number of single-term experts with staff support

– Access to tax authority and other privileged information

– Produce pre-Budget forecasts once a year, plus estimates of scale of all government liabilities

– State how much tightening/loosening appropriate in each Budget to be consistent with fiscal rules set by government

– Purely advisory role: no pre-commitment to accept advice

Would this have helped in the pre-crisis era?

• Might have encouraged earlier tightening from 2002, putting UK in stronger fiscal position when crisis hit

– But plenty of independent bodies advised this and were ignored

• Might have protected credibility of rules as guide to behaviour

– But lost credibility has not increased borrowing costs


Steady fall in interest rate on UK public debt

0

2

4

6

8

10

12

Perc

ent

Average nominal interest rate - outturns

Average nominal interest rate - Budget forecast

Would this have helped in the past?

• Might have encouraged earlier tightening from 2002, putting UK in stronger fiscal position when crisis hit

– But plenty of independent bodies advised this and were ignored

• Might have protected credibility of rules as guide to behaviour

– But lost credibility has not increased borrowing costs

• Unlikely to have avoided need for current consolidation

– As in early 1990s, need for big consolidation largely reflects HMT belief that potential GDP 4–5% lower than previously thought

– Government says fall in potential came out of the blue with banking crisis; but maybe previous boom went unrecognised

– Should fiscal policy have been much tighter in post 2002 period?

– Few were saying that then; if so, tough questions for monetary and macro-prudential policy too

A bust without a boom?

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6

1956

H2

1958

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H2

1962

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1966

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1968

H2

1970

H2

1972

H2

1974

H2

1976

H2

1978

H2

1980

H2

1982

H2

1984

H2

1986

H2

1988

H2

1990

H2

1992

H2

1994

H2

1996

H2

1998

H2

2000

H2

2002

H2

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H2

2008

H2

2010

H2

2012

H2

2014

H2

Out

put ga

p as

% o

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enti

al

Output gap: constant trend growth from 1997

Budget 2009 (showing lower trend)

The role and design of the OBR

• Commitment to new debt ceiling or medium-term deficit target unlikely to command much credibility given recent history. So:

– Persuade voters that painful multi-year consolidation will be stuck to

– Dissuade government from spending future positive revenue surprises

• Issues in OBR design

– Duplicate/replace HMT fiscal forecasting function?

– Interaction during policy formation process; speed of response?

– Macroeconomic inputs: own, central bank’s or other?

– Policy timescale: short-term prescriptions from medium-term target?

– Range of views versus single prescription; size and voting?

– Anything to say on composition of consolidation (IMF does)?

Final thoughts

• UK experience does provide evidence of fiscal short-termism

• Fiscal council could have helped, assuming government listened

• Should have taken cyclical judgement out of HMT’s hands and/or adopted a more forward-looking rule

• Fiscal council credibility may itself be fragile: in normal times typical policy adjustment smaller than forecasting error

• Big fiscal adjustments have followed big errors in estimating economic potential; hard to see fiscal council avoiding these

• Credibility of consolidation rather than long-term goal now key

• At the end of the day, commitment of Government essential

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