- We had already expected something big on fiscal policy in the Budget. But the change in Chancellor increases the chances that new, less restrictive fiscal rules are announced, and that government policy boosts the economy by more over the next few years than we had previously thought.
- Following the unexpected resignation of Sajid Javid as Chancellor and the promotion of Rishi Sunak (see here), it is not clear yet if the Budget will go ahead as planned on 11th March and whether the government will stick to its existing fiscal rules to balance the “current” budget (which excludes investment) by 2022/23 and cap investment spending at 3% of GDP.
- We wouldn’t be particularly surprised if the fiscal rules are bent or replaced. Fiscal rules don’t usually last long and change all the time. (See Chart 1.) And the economic and fiscal position appears to have worsened such that Javid probably wouldn’t have been able to raise spending significantly without increasing borrowing and breaching his balanced current budget rule. (See here.) Ultimately, we suspect that Javid was forced out as he was unwilling to bend the rules so that the Prime Minister could implement his political plan to spend big in order to “level up” the regions.
- As such, there now seems a very good chance that the new Chancellor, Rishi Sunak, either tweaks the current rules or announces some new, less restrictive rules. He won’t have a shortage of options to choose from. (See Table 1.) The fudge is to keep the existing fiscal rules, but bend them a bit. If he swaps the current three-year ahead balanced current budget target for a five-year ahead one or a rolling five-year ahead target, he would have more leeway to splash the cash in the next few years and put off any fiscal tightening until after the next general election in 2024.
- A more radical option would be to drop the balanced current budget objective altogether and replace it with a rule to limit total (i.e. including investment) public sector net borrowing. If he opted for a 3% cap in line with EU countries, that wouldn’t change the overall fiscal stance much. But it would allow the government to borrow not just to finance investment spending, but to finance tax cuts. And as long as the government could stomach a rising debt ratio, then it could opt for a 4% or 5% limit.
- Alternatively, a new fiscal framework could be put in place, but one that it is reasonably vague and focused on the medium-to long-term outlook. For example, there could be a limit for the debt ratio, perhaps 90%, or even a simple stop-gap measure setting a maximum amount of discretionary fiscal loosening, perhaps 1.5% of GDP. Sunak could, of course, go for the really radical option and jettison the fiscal rules altogether. But having no rules would leave the government open to political attack. And the government may judge it is better to set a rule demonstrating at least some semblance of fiscal prudence.
- Whatever fudge, stretch or alteration to the fiscal rules Sunak comes up with, the big picture is that the Budget will probably mark the beginning of the biggest fiscal boost seen since the financial crisis. We had already anticipated a loosening worth 0.5% of GDP in the Budget on top of the 0.5% already announced in the 2019 Spending Round. The change of Chancellor suggests the risks to that forecast are to the upside.
Chart 1: Duration of Main Fiscal Rule (Years)
Table 1: Possible New Fiscal Rules
Source: Capital Economics
Sources: IFS, Capital Economics
Ruth Gregory, Senior UK Economist, +44 20 7811 3913, email@example.com