Rachel Reeves's fiscal rules have become a bad joke

Yahoo

29-05-2025

That famous Hemingway quote – 'How did you go bankrupt? Two ways. Gradually, then suddenly' – has been much in use of late. For the moment, high income, advanced economies such as the UK are still in the 'gradually' phase, but the tipping point is approaching fast.
This should be obvious to almost everyone. Certainly it is now widely recognised in sovereign bond markets, where yields on longer dated maturities have risen to levels that factor in a real possibility of eventual default.
That's a big change in what hitherto has been regarded as the ultimate 'risk free' asset.
Investors are beginning to charge against the off chance they won't get their money back, or that some backdoor method of effective default might be pursued, such as inflation or currency devaluation.
Yet it is as if our politicians haven't even noticed. Only a few weeks back at the London Defence Conference, Sir Keir Starmer said that the organising principle of his Government was defence and security.
Good, you might have thought. Here's a Prime Minister who is finally beginning to get his priorities right.
Sadly, it was just words. As it turns out, the more important principle continues to be entitlement and dependency.
One way or another, Britain's beleaguered Chancellor, Rachel Reeves, is going to have to find the money both to reverse her own actions in cancelling the winter fuel allowance and to end the two child benefit cap imposed by preceding Tory governments.
Under pressure from backbenchers, she'll very probably also have to row back on at least some of the Government's reforms to disability benefits.
Sir Keir appears in no mood to resist these pressures. With Reform UK snapping at his heels, he's rediscovered some of his ideological roots, so uncomfortably repressed while pursuing power with the faux-promise of fiscal responsibility.
If Nigel Farage's Reform UK is now the main opposition to Labour, there's very little sign of economic realism from that quarter either, with the party now going full tilt at outdoing the Government on the winter fuel allowance and the two child cap.
It's a catastrophic political misjudgement on Farage's part. By swinging left, he's shown himself to be no different from the vote-chasing political mainstream.
The veil has fallen, and Farage is exposed as no more than an opportunistic paper tiger who prioritises unaffordable state dependency over sound economic judgment and what he believes to be right.
Reform's emerging policy mix of fantasy economics and wishful thinking outbids even Labour in its determination to bankrupt the country.
People aren't stupid, and my guess is that they'll see straight through Farage's cynically motivated make-believe.
Reform's attempt to stand for both red in tooth and claw capitalism and high dependency state handouts is a contradiction in terms, and doomed to fail.
In the meantime, the public finances are on course for how Elon Musk's SpaceX describes a rocket launch failure – 'a rapid unscheduled disassembly'.
As is usually the case, the International Monetary Fund (IMF) pulled its punches in its annual Article IV assessment of the UK economy this week.
It even offered the Chancellor a glimmer of hope by giving her cover, should she choose to use it, for yet another change in the fiscal rules.
The point the IMF makes is actually a reasonably sound one. As they stand, the rules create significant pressure for frequent changes in fiscal policy.
Intense market and media scrutiny surrounds the so-called 'headroom', or discretion in tax and spend policies, that the rules dictate.
Small downward revisions by the Office for Budget Responsibility (OBR) to the economic outlook tend to erode any available headroom, and therefore require repeated, often on the hoof, adjustment to fiscal policy so as to stay within the rules.
This is obviously not healthy. But nor are the fiscal rules as a whole. These have become almost Kafkaesque in their application and seemingly arbitrary power to influence policy.
Certainly they seem to be doing no good at all in their central purpose of putting the public finances back on a more sustainable footing.
The first of Reeves's rules require the current Budget to be in balance or surplus from the third year of a rolling forecast period.
Sounds good in theory, but the effect of a constantly receding horizon is that it allows debt relative to national income to keep rising even though the rule is technically met by committing to future action that in practice rarely happens.
The Chancellor defends the rolling horizon by arguing that it avoids the need to make sharp policy adjustments in response to small changes in the forecast.
Yet as Lord King, the former governor to the Bank of England, pointed out in a recent speech in the House of Lords, Reeves did exactly that in her Spring Statement; she promised to cut spending to meet a change in the OBR's point forecast for 2029-30.
The extraordinary expenditures of the pandemic are now supposedly behind us, and we have still to see any significant increase in defence spending, yet year after year, debt continues to rise as a proportion of national income.
The rules are essentially useless in doing what they are supposed to – putting debt on a downward trajectory. Even as a way of bolstering the Government's credibility in financial markets, they are increasingly impotent. Everyone can see straight through them.
The Chancellor insists that her rules are 'iron clad' and non-negotiable. A little while back, she also told the CBI annual conference – after announcing a £40bn tax-raising budget – that she would not be coming back with more tax rises or borrowing.
On neither count did anyone believe her back then, and they believe her even less today, with the gamble on growth coming to the rescue self-evidently failing.
The current fiscal rules are the 10th such iteration since Gordon Brown introduced his original 'golden rule' back in 1997, and pretty much each set of rules has made it slightly easier for the government to borrow to spend than the previous one.
The only way of stopping this treadmill of rising indebtedness is to have a simple overarching rule that growth in spending must always be lower than growth in the economy, subject to the exception of large external shocks.
Alternatively, a fixed target date of say five years for debt to be lower than it is today, as recommended by the House of Lords economic affairs committee, might serve equally well.
All else is just a game of charades that increasingly fails to convince anyone. We are going bust gradually at the moment, but with steeply rising debt servicing costs, we are perilously close to the point of no return.
Meanwhile, the politicians keep on promising more and more. If it wasn't so reckless, it would be laughable. No household or company would get away with managing its finances like this.
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