A fragile fiscal Charter

19 December 2014

Earlier this week the Government announced a new Charter for Fiscal Responsibility. The Charter sets out the Government’s fiscal rule that it promises to abide by, and requires the Office for Budget Responsibility to assess it against. The new Charter lightly updates the previous version in two ways:

  1. It requires the Government to forecast a cyclically-adjusted current account surplus within three years, rather than the previous five year period.
  2. Public sector net debt should fall as a percentage of GDP in 2016-17, a year later than in the previous Charter.

Reform has written extensively about the problems with fiscal rules that are tied to fixed dates. Essentially, they are unable to respond to changing economic circumstances, which makes them extremely fragile and prone to being broken. Because they can reasonably be broken without repercussions they do not create an effective control upon the Government’s plans.

The restriction on net debt is exactly that sort of rule. It is intended to be the fixed anchor for the Government’s fiscal plans. The first element of the rule applies only to forecasts, not out-turns. So long as the Government forecasts balance within three years it meets that criterion. The second element anchors the rule to actual data, not just a forecast. The intention is laudable but fragile rules are no more than window-dressing and will not ensure genuine fiscal sustainability.

The Office for Budget Responsibility’s own forecasts demonstrate the fragility of the debt rule. Below I have plotted the debt and deficit paths from their Autumn Statement forecasts. The three paths relate to three possible paths for productivity growth. If the current stagnation of productivity continues, as it has done since 2007, then the Government is forecast to break its debt rule. To satisfy the rule, the Government will need productivity growth to increase fourfold, as in the central forecast. To meet it a year early the Government needs productivity to rise eightfold.
How likely is it that productivity growth will rise? The chart below shows how persistently optimistic official forecasts of productivity growth have been. If the ‘low productivity’ forecast of the 2014 Autumn Statement comes to pass that will mean rising debt for the entire forecast period. It is all too plausible to take comfort in the Government’s new fiscal framework.

James Zuccollo is Senior Economist at Reform

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