With the Conservatives and the Labour Party now competing on fiscal profligacy rather than fiscal prudence, it is unsurprising that the Chancellor Sajid Javid announced today a full rewrite of the fiscal rules. But the new rules still allow a big fiscal loosening regardless of who wins the 12th December election.
- With the Conservatives and the Labour Party now competing on fiscal profligacy rather than fiscal prudence, it is unsurprising that the Chancellor Sajid Javid announced today a full rewrite of the fiscal rules. But the new rules still allow a big fiscal loosening regardless of who wins the 12th December election.
- As we had expected, the new fiscal rules announced by the Chancellor Sajid Javid today were couched in terms of balancing the “current budget deficit” i.e. excluding investment spending. (Se our UK Economics Focus, “Rewriting the fiscal rules”, 24th October 2019.) In addition, Javid announced three further conditions. First, that net investment should not exceed 3% of GDP. Second, that if borrowing costs were to exceed their historical average that could lead to a reassessment of investment spending. And third, that the debt to GDP ratio should be lower at the end of the next Parliament than at the start.
- So how much “fiscal headroom” would this leave the Chancellor? There is no confirmation yet as to the time horizon over which the rules will apply. But current borrowing has already fallen below zero in the last 2018/19 fiscal year. And according to the OBR’s spring 2019 forecast, the surplus was forecast to increase to 1.6% of GDP (or about £40.3bn) by 2023/24. (See Chart 1.)
- Admittedly, things have changed since the OBR’s last forecast in March. And the Cabinet Secretary cancelled the Office for Budget Responsibility’s (OBR) forecast due to be released today. Luckily, though, we produced our own version of the OBR’s figures yesterday, in which we concluded that the OBR would raise its borrowing forecast, perhaps by £15bn per annum. (See our UK Economics Focus, “OBR to drive final nail into the fiscal rules coffin” 6th November.) As a result, had the OBR published its forecasts today, it may have shown that any headroom against the new fiscal target for a balanced current budget would have been reduced by some £15bn, down from £40.3bn perhaps to around £25bn.
- And that forecast would have incorporated only methodology changes. If the OBR had included the increase in spending announced in September’s 2019 Spending Round and the recent deterioration in the economic and fiscal backdrop, we estimate that this could have added another £22bn or so to its borrowing forecasts. That would have all-but eliminated any headroom against the Chancellor’s new fiscal rule. It is no wonder then that Javid has previously ruled out implementing at least some of Boris Johnson’s previous tax pledges, to raise the income tax threshold and increase the NICs threshold – which would have cost £20bn.
- The new rules do by design, allow for a huge increase in investment spending of 1% of GDP (or around £22bn per annum) from 2% now to 3% of GDP. (See Chart 2.) But that is far smaller than Labour’s promise today to increase investment spending, some have suggested by about £55bn per annum. And in reality, our back of the envelope calculations suggest that Javid may not be able to increase spending by much more than £15bn per annum (0.6% of GDP) whilst still claiming that the debt to GDP ratio is falling over the Parliament.
- Even so, significantly looser fiscal policy is on the way regardless of whether the Conservatives or Labour are in power, representing a rare upside risk to our GDP growth forecasts.
Chart 1: Current Borrowing (As a % of GDP)
Chart 2: Public Sector Net Investment (As a % of GDP)
Ruth Gregory, Senior UK Economist, +44 20 7811 3913, email@example.com