Tinkering with the rules won’t stop debt from rising
Rachel Reeves’s first budget, on October 30, is more than 11 weeks away. By then, the leaves will be falling and this summer will be but a distant memory. Yet it is already attracting more attention than is probably healthy, in which spirit let me add a little to it.
On a visit to America in recent days, the chancellor has refused to quell speculation that she will use a different definition of debt to measure whether she is meeting her “non-negotiable” fiscal rules.
I have been asked quite a lot about this, so a brief explanation is necessary. The measure of debt with which most people will be familiar is the one announced every month by the Office for National Statistics (ONS). This measure, public sector net debt, stood at £2.74 trillion (£2,740 billion) at the end of June, the latest estimate, equivalent to 99.5 per cent of gross domestic product (GDP).
It has been on an extraordinary journey. In the early 2000s, debt was just over £300 billion — less than 28 per cent of GDP. Immediately before the pandemic, it was below 80 per cent of GDP. It has risen by £1 trillion over the past six years and £2 trillion over the past 15½.
There is another measure of debt, though, which is the one that Reeves has inherited from the Tories for the purpose of the fiscal rules. This is net debt excluding the Bank of England, which at the end of June was £2.52 trillion, or 91.6 per cent of GDP.
The suggestion is that the chancellor will switch from this measure, sometimes called underlying debt, to the more familiar figure. Why would anybody switch from a lower to a higher measure of debt? Having written here some time ago that this might happen, I should explain.
If we take the latest forecast from the Office for Budget Responsibility (OBR), the economic and fiscal watchdog, it had the underlying measure of debt rising further to 93.2 per cent of GDP, before slipping to 92.9 per cent in the fifth year of the OBR’s forecasting period, 2028-29, as required by the fiscal rule. The government scraped home, by just £8.9 billion.
The raw debt figure, including the Bank, in contrast, shows a fall starting in 2025-26 and continuing throughout the period. In 2028-29 alone, switching the debt target would release an additional £16 billion-plus of headroom, according to the Institute for Fiscal Studies (IFS). Tempting. It might be possible to release a lot more, if the aim was simply to have debt edging slightly lower each year from next year’s temporary peak.
The difference between the two debt measures is due to the unwinding of the Bank’s term funding scheme and losses on its quantitative easing (QE) programme. But any gains are temporary. Early in the next parliament, the two debt measures converge.
The IFS, in a briefing note, takes a dim view of changing the debt measure to make it easier to meet the rule. Describing this as “moving the fiscal goalposts”, it suggests that it is hard to see “a principled case” for a change.
“Any such change would almost certainly be motivated by the impact on so-called ‘fiscal headroom’ and the fact that additional borrowing would be possible without breaching the letter of the rule, at least in the short term,” it says. “If the government wants to borrow more and spend more, it would ideally make the case for doing so on its own terms, rather than hide behind fiscal jiggery-pokery.” Harsh but probably fair.
For many economists, a change in the debt definition is like rearranging the deckchairs, if not on the Titanic, at least on an ocean liner that is not entirely seaworthy.
The National Institute of Economic and Social Research (Niesr), our oldest economic think tank, argues in its latest review that the Labour government, constrained by fiscal rules, is unlikely to meet its objective of raising the economy’s growth rate by enough.
The UK needs more investment, it says, including raising public investment to 5 per cent of GDP from 2.5 per cent now. That is equivalent to an extra £50 billion a year, with “targeted public investment projects in key areas such as housing, transport connectivity, education and skills, [and] close co-ordination of a national growth strategy with local and regional growth plans”. The only way the government will be able to do that under the current fiscal rules will be to raise taxes, it says, which will itself bear down on growth.
Jagjit Chadha, Niesr’s director, puts it well in the review. “At first glance, our fiscal rules would seem to make a lot of sense,” he writes. “And yet a poorly formulated rule may not only distort decision-making but may stand in the way of achieving social and economic progress.
“The current rules target the instrument, public debt, rather than the objective of policy, and we do not have a fully established set of analyses that allow us to trace the best … path for debt, or mix of debt and tax, following shocks … The current rule of expecting debt as a share of output to fall in the fifth year of a forecast does not even guarantee debt sustainability, because debt in year five could still be above where it is in year one and the rule would be met.”
That’s a lot for a new chancellor to think about. Having made her commitment to fiscal responsibility clear, she probably has no choice but to follow something similar to the last government’s fiscal rules.Those rules, which tend to be broken when the going gets tough, have not prevented the sharp rise in government debt described above, nor are likely to do so in the future.
The OBR had to postpone this year’s report on long-term fiscal risks because of the election. Last year’s, however, had a baseline forecast of a rise in government debt to 300 per cent of GDP over the next 50 years — or nearly 450 per cent, assuming the coming decades bring more of the kind of shocks seen so far this century. Sustainable it is not.
PS
Whenever I hear of Elon Musk, I always think it sounds like a great name for a cheap men’s fragrance. Otherwise, the silly clickbaiter is better ignored. Talking of clickbait, though, our very own ONS engaged in an unintentional episode nearly a year ago. Without warning, it released new “Blue Book” figures for economic growth showing that the UK was no longer bottom of the class for its performance since the start of the pandemic, as had been thought.
Well, the ONS has been at it again, though not so dramatically this time. Thanks to new estimates and changes in methodology, it has revised up 2022’s growth rate from 4.3 per cent to 4.8 per cent. That remains a strange year — one in which most of the growth reflected the fact that GDP in the first quarter was 11.5 per cent up on the lockdown-affected first quarter of 2021.
But 2022, which is as far as the revisions go, was a slightly different year than previously reported. We had thought the economy had flatlined from early 2022 to the end of 2023, when it entered a mild “technical” recession. Now there’s a smidgeon more growth through 2022 than we knew about, and in time I am sure that technical recession of late 2023 will be revised away.
Had Rishi Sunak been able to delay the election for a lot longer, probably longer than was legally possible, he might have been able to claim that the economy was in better shape. GDP per head, instead of being slightly down on pre-pandemic levels at the end of 2022, was slightly up in the new figures. We will have to wait until other countries have completed their revisions to see where all this places us.
The figures do not in any way rescue the reputation of Liz Truss’s premiership, as some suggest. She crashed the pound, created a crisis in the gilt market and caused misery for millions of people with mortgages. She was not there long enough to drive the economy into recession and her mini-budget was quickly reversed.
Meanwhile, these revisions, while necessary, change other narratives. One of those was that households had been very cautious about spending, particularly when the cost of living crisis hit, and had been slow to reduce pandemic saving to buy goods and services. The new estimates suggest instead that the saving ratio fell to a “normal” 6 per cent in 2022, rather than the 8 per cent previously estimated, and that consumer spending was £34 billion more than thought. As always, we are chasing a moving target.
