There’s been frantic speculation, at least in those circles interested in such matters, that the government is set to revise the fiscal framework inherited from the Conservatives. Or, put bluntly, to borrow loads more money and bump up the national debt, already running at about a 60-year high. While no one expects the temperamentally cautious Rachel Reeves to “do a Truss” and launch a shock Budget with vastly bigger borrowing targets, there are legitimate concerns about the impact on interest rates and, thus, mortgages and business confidence. Reeves is under enormous pressure to spend more on public services and invest to improve growth. It’s all very tight, but she does have options…
Why can’t we borrow what we need?
We can, and governments have done so many times, for good and bad reasons. The problem is that it can also push inflation and interest rates higher, thus making economic matters worse. The government now, for example, spends more on paying interest on its debts (about £100bn a year) than on defence (£53bn) or schools (£92bn). Because of the cost of rescuing banks in the global financial crisis of 2008, the ongoing damage inflicted by Brexit, the debts run up by pandemic support measures, and similar measures in the recent energy crisis, the national debt has ballooned to about 100 per cent of national income. Now interest rates are more normal, it’s becoming a burden.
What are the fiscal rules?
At the moment the main one is simple – to get the national debt on a downward path in five years’ time. It is an arbitrary framework and, given that it’s a rolling target rather than one aiming at a fixed date, all too easily manipulated and rolled over. At the moment, the projection sees debt falling by about £9bn in five years – Reeves’s margin of safety or “headroom”. On a total debt approaching £3 trillion, it’s not much.
What could Reeves do?
She could keep the five-year rule but change the definition of debt. One reform would be to exclude any losses incurred by the Bank of England as it runs monetary policy – a technical change that would free up some extra “headroom” (about £25bn). A more radical idea would be to define it as “public sector net financial liabilities” or, more likely, “public sector net worth”. These look at things more in the round, what assets the public sector owns as well as the money it owes. It’s like putting your mortgage repayments in the context of the value of your home, and the cost of a new extension set against the enhanced value of the property.
Experts say that the most liberal redefinition of the national debt could yield Reeves another £67bn of “headroom” on the five-year horizon.
So why the panic over the “black hole”?
The problem has been created by “current spending” – welfare payments, public sector wages – rather than capital spending, which should raise productivity and increase output and growth, and thus pay for itself in the longer run by making the economy (and future tax take) bigger. Reeves’s fundamental problem is trying to get Britain’s sluggish economy to grow faster. Brexit constrains that on the trade and investment side.
In other words, Reeves will probably have to keep on with the tax hikes and cuts to the benefits bill, even if she borrows to build, say, more roads and railways and subsidises green technology. If she was minded to be radical she could bring back the £28bn green new deal and extend HS2 to the North, provided investors can be persuaded that these schemes would yield faster growth in future and a proper return on investment. What Reeves can’t do is borrow to make deep cuts in taxation, Truss-style.
Wouldn’t there be a market meltdown and run on the pound?
Not if Reeves makes sure that her “borrow to invest” drive is fully transparent, with the borrowed money clearly directed to productive viable public infrastructure projects.
Consulting the Office for Budget Responsibility and the Bank of England on a change to the debt definition (or other rule changes) means that likely market reactions can be tested in advance, and public discussion of the options now can also help lessen any nasty surprises. That’s the key to avoiding a rerun of the 2022 mini-Budget fiasco; the Budget on 30 October will still be one of the most painful in recent decades.
What are the politics of this?
The Tories would accuse Reeves of breaking her promise and being profligate. But if the markets take it in their stride and the growth benefits begin to feed through, it will help Labour make the economic case for a second term. Besides, it will take the Conservatives some years to live down the austerity years and that atrocious mini-Budget.