Fiscal (in)discipline: the UK
experience
Robert Chote
International Monetary Fund, 2 June 2009
© Institute for Fiscal Studies
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
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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
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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
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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)
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-8
19 0
81
-8
19 2
83
-8
19 4
85
-8
19 6
87
-8
19 8
89
-9
19 0
91
-9
19 2
93
-9
19 4
95
-9
19 6
97
-9
19 8
99
-0
20 0
01
-0
20 2
03
-0
20 4
05
-0
20 6
07
-0
20 8
09
-1
20 0
11
-1
20 2
13
-1
20 4
15
-1
6
19
79
Percent of national income
Golden rule: public sector current balance
4
2
Budget forecast
Out t urns
Average for cycle
0
-2
-4
-6
-8
-10
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Sustainable investment rule: public sector net debt
Percentage of national income
100
IFS extrapolation
Budget forecast
80
Outturns
60
40% ceiling
40
20
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Note: Excludes unrealised losses on financial interventions.
Sources: HM Treasury; IFS calculations.
2040-41
2035-36
2030-31
2025-26
2020-21
2015-16
2010-11
2005-06
2000-01
1995-96
1990-91
1985-86
1980-81
1975-76
0
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
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Serially overoptimistic current budget forecasts
4
Budget 01
Budget 02
2
Budget 03
1
Budget 04
0
Budget 05
-1
Budget 06
Budget 07
-2
-3
99
–0
00 0
–0
01 1
–0
02 2
–0
03 3
–0
04 4
–0
05 5
–0
06 6
–0
07 7
–0
08 8
–0
09 9
–1
10 0
–1
11 1
–1
12 2
–1
3
% of national income
3
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
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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)
The problem: more borrowing, mostly structural
Public sector net borrowing in Budget 2009, excluding PBR and Budget policy
measures
Percentage of national income
0
-2
-4
-6
-8
-10
Sources: HM Treasury; IFS calculations; figures may not add due to rounding.
© Institute for Fiscal Studies
2017-18
2016-17
2015-16
2013-14
2012-13
2011-12
2010-11
2009-10
2008-09
-14
2014-15
Extra cyclical borrowing
Extra structural borrowing
Borrowing in Budget 2008
-12
The problem: more borrowing, mostly structural
Public sector net borrowing in Budget 2009, excluding PBR and Budget policy
measures
Percentage of national income
0
-2
-4
-6
-8
-10
Sources: HM Treasury; IFS calculations; figures may not add due to rounding.
© Institute for Fiscal Studies
2017-18
2016-17
2015-16
2013-14
2012-13
2011-12
2010-11
2009-10
2008-09
-14
2014-15
Extra cyclical borrowing
Extra structural borrowing
Borrowing in Budget 2008
-12
The problem: more borrowing, mostly structural
Public sector net borrowing in Budget 2009, excluding PBR and Budget policy
measures
Percentage of national income
0
-2
-4
-6
-8
-10
Sources: HM Treasury; IFS calculations; figures may not add due to rounding.
© Institute for Fiscal Studies
2017-18
2016-17
2015-16
2013-14
2012-13
2011-12
2010-11
2009-10
2008-09
-14
2014-15
Extra cyclical borrowing
Extra structural borrowing
Borrowing in Budget 2008
-12
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?
6
5
4
3
Tax or current spending
Investment changes
Current spending changes
Tax changes
2
1
0
-1
© Institute for Fiscal Studies
Sources: HM Treasury; IFS calculations.
2017-18
2016-17
2015-16
2014-15
2013-14
2012-13
2011-12
2010-11
2009-10
-2
2008-09
Percentage of national income
7
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
12
10
Percent
8
6
4
Average nominal interest rate - outturns
Average nominal interest rate - Budget forecast
2
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11
20
10
-
06
20
05
-
01
20
00
-
96
19
95
-
91
19
90
-
86
19
85
-
81
80
19
19
75
-
76
0
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
5
19 6H2
5
19 8H
6 2
19 0H2
6
19 2H
6 2
19 4H2
6
19 6H
6 2
19 8H2
7
19 0H
7 2
19 2H2
7
19 4H
7 2
19 6H2
7
19 8H
8 2
19 0H2
8
19 2H
8 2
19 4H2
8
19 6H
8 2
19 8H2
9
19 0H
9 2
19 2H2
9
19 4H
9 2
19 6H2
9
20 8H
0 2
20 0H2
0
20 2H
0 2
20 4H2
0
20 6H
0 2
20 8H2
1
20 0H
1 2
20 2H2
14
H
2
19
Out put gap as % of pot ent ial
A bust without a boom?
6
4
2
0
-2
-4
-6
-8
-10
Output gap: constant trend growth from 1997
Budget 2009 (showing lower trend)
-12
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