Can Labour deliver the promised decade of national renewal while following its Fiscal Rules?

By Mark E Thomas and Vince Gomez.

When he became Chancellor, Jeremy Hunt set out new Fiscal Rules in an effort to appear responsible after Truss and Kwarteng.

Even before she became Chancellor, Rachel Reeves – also in an effort to appear responsible – said that Labour will follow very similar rules: she said, “We will not borrow to fund day-to-day spending and we will reduce national debt as a share of the economy”

That sounds rather restrictive – and poses the question: will these restrictions prevent Labour from being successful in their attempt to rebuild the UK?

In this article, we argue that the rules will cause failure to deliver if Labour are doctrinaire and uncreative, but not if they take full advantage of the fact that the UK has been running a fiat currency system for well over half a century:

• A narrow interpretation of the rules, as Hunt intended, will require yet further austerity which the UK cannot afford.
• In a fiat currency system, government borrowing and debt need not be barriers to progress and the fiscal rules need not stifle the economy;
• The real issue is physical resources – manpower, food, raw materials, etc – and this will require very careful handling if Labour is to succeed.

The UK cannot afford a narrow interpretation of the rules

Although most commentators treat the Chancellor’s Fiscal Rules as being in some sense rules of economic probity, in reality, they are arbitrary – each new Chancellor makes up his or her own. In fact, we have had at least nine iterations of these rules since they were initially adopted by UK governments in 1997.

If the Fiscal Rules are not economic rules, what are they? They are political devices for Chancellors, which can serve at least two purposes:

1. Appearing responsible: this was Gordon Brown’s thinking in 1997, as it was for Hunt, who wished to distinguish himself from Kwarteng; and Reeves who had to tackle the media narrative of ‘Labour fiscal irresponsibility’;
2. Giving cover for austerity: A chancellor whose aim is to shrink the state can claim to be being ‘responsible’ and ‘not ducking the difficult decisions’ if they are following their fiscal rules – this enabled Osborne to avoid scrutiny for his damaging austerity programme; and it would have given similar cover to Hunt, had the Conservatives been re-elected.

The Fiscal Rules are usually interpreted narrowly, as though Britain were still on the gold standard. And there almost seems to be a deliberate misunderstanding on the part of both politicians and commentators of how a non-commodity based monetary system works. Hardly any analysis of government finances in the media makes the point that the government can and does create money whenever it needs to – £895 billion since 2009. Given that it is inconceivable that this enormous power to create money has no economic impact, that it is so seldom even mentioned is extremely strange. We made this point in more detail in our Submission to the House of Lords Inquiry into Debt Sustainability.

If Reeves were to adopt Hunt’s intended interpretation, which is that the rules should be met without taking advantage of the fiat currency system, she will not be able to avoid austerity without significant tax rises, which Labour have been trying to avoid. According to the Resolution Foundation, £19 billion in cuts for unprotected departments by 2028-2029 are baked into the latest Budgetary figures. This would be devastating for Britain’s already failing public services. There is an increasing body of evidence that another round of austerity would be unthinkably damaging (and not, as we have seen since 2010, help bring down debt: GDP).

We simply cannot afford a narrow interpretation of the Fiscal Rules.

Government borrowing and debt need not be barriers

Fortunately, in a fiat currency system, shortage of money is never an excuse for inaction. And we need action on a grand scale now.

Two kinds of spending are needed: day-to-day and investment. And the Fiscal Rules are most restrictive on day-to-day spending. But given how much of what needs doing can be seen as long-term investments for the good of the country – a green transition, rebuilding crumbling hospitals and schools, new technology, etc –  that opens up a lot of wriggle-room.

We also need to rethink how we estimate the long-term impact of investment spending on the economy. The OBR currently assumes a maximum multiplier of 1  meaning that. in their forecasts, the government can never stimulate more in growth than it spends – indeed overall, their forecasts assume that government spending ‘crowds out’ private sector spending and therefore harms the economy. This assumption flies in the face of empirical reality. A recent IMF report found that real-world evidence points to a powerful ‘crowding-in’ effect: “a dollar of government investment raises private investment by about two dollars, and output by 1.5 dollars.” If Budgetary Responsibility is assessed in such a counter-factual way, what hope have politicians of formulating sound Budgets? Is it any wonder that we persistently underinvest?

The good news is that, even without more borrowing, tackling the immense amounts of ‘leakage’ from government finances will provide £ tens of billions extra for worthwhile spending.  In total, if all the leaks were completely plugged, the benefit to UK citizens in general (though not those who have been on the receiving end of the leakage) would be a truly staggering £250 billion per annum.

And on reducing debt: currently around 25% of so-called government debt is owed to the Bank of England (a subsidiary of the Treasury). That debt could simply be cancelled, as it would be if it were corporate debt, to hit the target.

The rule about debt reduction is reminiscent of the prayer of Saint Augustine; “Lord, give me chastity and continence, but not yet.” It hinges on uncertain future elements: expected shifts in public finances and economic predictions for the upcoming five years, ultimately ending in a hypothetical point that is never actually reached. Both factors are fraught with significant unpredictability – as the events since 2019 have shown us.

Taking the above factors into consideration makes it clear that a determined government need not be prevented by the Fiscal Rules from doing what the country needs.

The real issue is physical resources

But despite the points above, there are real barriers – governments can always create money when they need it, but they cannot print teachers, doctors or peas and carrots.

It is often said that we cannot “afford” to tackle food poverty amongst our most vulnerable children in schools. The prevalent economic ideology over the last four decades has largely convinced two generations of citizens, including policy makers, that the state is powerless and incapable of providing the necessary goods and services that a modern society is capable of delivering. The fact that the state was the only agent able to support the economy during WWII, the Global Financial Crisis and most recently COVID seems to have been forgotten.

As John Maynard Keynes said in 1942, “Assuredly we can afford this and much more. Anything we can actually do, we can afford. Once done, it is there. Nothing can take it from us. We are immeasurably richer than our predecessors. Is it not evident that some sophistry, some fallacy, governs our collective action if we are forced to be so much meaner than they in the embellishments of life?”

The question is not whether we can find the money to provide the 4.3 million children living in poverty in the UK with free school meals, but whether we have the protein and vegetables available to us as a country to deliver. It is a question of peas and carrots, not one of gold. We should be talking about farming policy, food security and import substitution, not where we can find the money.

To repair the UK will require diversion of real resources to the task of rebuilding: we will need to reduce demand for certain goods and services via taxation elsewhere in the system, to free them up to tackle vital national challenges without stoking inflation. So, while the state is in no way dependent on private sector taxes to give it the money for spending,  carefully targeted tax is necessary to remove some private spending capacity and prevent inflation.

During WWI, Keynes had to figure out how to reshape the economy without stoking inflation or starving the poor. He thought radically; we need radical policies now.

Conclusion

It is certainly true that the UK faces a major (and difficult) task of national renewal after the last 14 years. It is not true that we cannot find the money to do so; and it is not even true that the government would have to ditch its Fiscal Rules to succeed. But it is true that a narrow interpretation of the rules would guarantee failure.

What the UK cannot afford is to allow gold-standard thinking to derail the effort to rebuild the fabric of the nation.

Mark is the author of 99%: Mass Impoverishment and How We Can End It. Vince is a former investment banker and member of the Bank of England’s Citizens’ Forum. Both are members of the 99% Organisation, an all-volunteer group whose objectives are to strengthen the UK’s social contract and end mass impoverishment.