“Living within means”

Last night, the Fiscal Charter, blogged about yesterday and the day before, passed in Parliament. Aside from the politics of Labour’s stance on it, the essence of this charter is that governments must run budget surpluses (so tax receipts must be higher than government spending) in the economic “good times” (defined as real GDP growth of less than 1% a year, as measured on a rolling four-quarter basis).

This is far from the first set of fiscal rules devised by a government or governments; Gordon Brown famously had his golden rule of only borrowing to invest over “the cycle” – so balance the current budget (spending on current consumption like on benefits), but allow borrowing for public infrastructure projects, while the eurozone has the Stability and Growth Pact, which limits deficits and debt levels of eurozone members. Brown’s rule was never enshrined in law, of course, but this need not make a particularly large difference since it’s not at all clear how any deviation from the fiscal charter would be punished, should it happen.

However, the main thing I want to write about this morning is a message we often hear, namely that Britain must “live within its means”. It is simply another way of implying that governments have to be like households, but yesterday I talked about why, outside the eurozone and provided a government can borrow in its own currency, that’s not a useful comparison.

One’s own means include its credibility as a debtor; are we expected to repay debts we incur? Because the vast majority of households in the UK take on gigantic mortgages at some point in their lives, many multiples of the size of their income, but do so on the basis that they will be able to pay off that large loan over a long period of time: they are credit-worthy. If a government can print its own money and borrow in that currency, then it is creditworthy – it will be able to pay back, even if the resulting money is worth less due to inflation.

Hence living within one’s means need not mean running a surplus and never borrowing, just as it doesn’t mean that for a household. More next term…

What is this “Fiscal Charter”?

The main news this morning is overtly political: Labour have apparently performed a U-turn and now oppose the Fiscal Charter than the Chancellor, George Osborne, has proposed. While the U-turn is obviously a political story, and Labour is a political party with plenty of problems at the moment, the Fiscal Charter is something that very much invokes economics, and economic analysis.

What is this Fiscal Charter? Here’s what George Osborne said in his Summer Budget Speech back on July 8 2015:

Today I publish the new Fiscal Charter that commits our country to that path of budget responsibility.

While we move from deficit to surplus, this Charter commits us to keeping debt falling as a share of GDP [Gross Domestic Product] each and every year– and to achieving that budget surplus by 2019-20.

Thereafter, governments will be required to maintain that surplus in normal times – in other words, when there isn’t a recession or a marked slowdown.

Only when the OBR [Office for Budget Responsibility] judge that we have real GDP growth of less than 1% a year, as measured on a rolling four-quarter basis, will that surplus no longer be required.

So in “normal” economic times, governments must run a budget surplus – something that will be enshrined in law should it be passed through parliament this Autumn.

The budget surplus is the difference between government receipts and government spending: T-G, in econ-maths-speak. It is different from government debt, which can crudely be thought of as the cumulation of previous budget deficits – when (T-G)<0.

It seems eminently sensible that when the economy is growing, governments should not be running deficits: in the good times, governments do not need to stimulate economic activity via tax cuts and extra spending projects, and indeed they collect more in various taxes: income tax, corporation tax, VAT, and so on.

However, this next graph suggests that UK governments for centuries have not been very good at this:

gov-surplus-1700

Going back to 1700, looking at 315 years of data, in only 83 of those has the UK government run a surplus; less than a third of the time. A casual glance also shows that the positive/negative split bears no resemblance to which party, left or right, has been in power; for almost all of the 1960s and 1970s, when both major parties had spells in power, the government almost exclusively ran deficits.

Of course, this doesn’t mean that Osborne’s charter is a bad thing: if it forces governments to run surpluses, this must be a good thing for the national debt? There’s loads to say about this, and we’ll say a lot more come the Spring in EC114, but for now it’s worth pointing out that the national debt (the cumulated overspends of UK governments) is not only reduced by running a surplus; despite the UK running deficits for much of the post-WW2 period, the following graph shows that UK national debt fell from 238% of GDP in 1948 to 42% by 1980:

ukgs_line

 

So a budget surplus is not essential for reducing the national debt burden. Indeed, many argue it may even hinder this; after all, the UK economy has performed well over the last 315 years despite predominantly having a government operating a deficit. In part, this is because governments invest in public infrastructure projects that can facilitate growth: transport and telecommunications networks, for example.

And this is where Labour appears to be in a muddle about the Fiscal Charter. The Fiscal Charter as Osborne outlined makes no room even for investing in public projects, focussing only on the budget as a whole. Often we split the budget into that for current consumption and that for investment: the part for current consumption (things we spend now: benefits mainly) is referred to often as the structural balance. Labour wants to still be able to spend on infrastructure projects in the good times, whereas Osborne’s Fiscal Charter rules even that out.

More in the Spring 🙂