UK sticks to EU-style fiscal rules but that is about to change

If you thought the UK’s departure from the EU would free it to do things differently from its neighbours on the continent, consider this: on both sides of the Channel, governments are increasingly going to find their tax and spending choices framed by fiscal rules.

In EU countries, such rules have been part of their governance since the Maastricht treaty and were particularly salient in the recovery from the 2008-12 debt crises (a recovery they undermined).

They have been suspended since the pandemic, but are supposed to be reactivated from the end of next year. By then, the hope is that they will be significantly reformed – the commission laid out its ideas this month.

In the UK, meanwhile, the painful plan for fiscal consolidation presented last Thursday by Jeremy Hunt, the chancellor, was driven by his fiscal rule that public debt should be falling as a share of gross domestic product five years from now.

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He also added another rule, a very Maastricht-like limit on the public deficit of 3 per cent of GDP at the same horizon. If Brexit was about freedom, what freedom is this?

There are of course differences. If the EU decides on reform along Brussels’ proposed lines, the rules will enforce a yearly public expenditure path to achieve sustainable debts and deficits, rather than aiming directly at the latter.

The budgeting horizon will be four years, and could be extended to seven when combined with structural reforms and investments that boost growth or contribute to common EU objectives.

This means the rules will no longer apply merely to aggregate fiscal quantities – as they have in the past and as Hunt’s rules do – but shape the composition and substantive content of taxation and spending. That should encourage better economic policy.

[ Shhh, don’t mention the Brexit war ]

The biggest contrast, however, is that EU members face rules enforced from the outside. National policy choices are constrained by treaty obligations, scrutinised by a transnational bureaucracy, second-guessed by peer governments, and in extremis financial sanctions.

All of which grates badly against certain views of the UK’s constitutional tradition and of sovereignty – both views are strongly held in a Conservative party that has made notable efforts to weaken outside constraints on executive power.

The Bank of England’s freedom is supposed to be superior to the constrained European Central Bank.

So it is not surprising that in the British context, “rules” are a different beast altogether. The UK government’s fiscal rules are set domestically, and can (as Hunt showed) be changed by nothing more than a chancellor’s speech.

They are defined on a “rolling” basis – the date by which the targets should be met always moves further into the future. Complying is therefore a matter not of doing what one has said, but of announcing every year that enough will be done in the following five.

Such rules should not really be thought of as rules at all. At best, they are principles – and if markets, voters, or MPs from the governing party do not like those principles, ministers can surely find others.

In contrast, the proposed EU rules would lay down a fixed path. Brussels hints that fiscal programmes could be aligned with member states’ electoral cycles.

That would improve the democratic anchoring of difficult decisions and reduce the credibility problem of committing future ministers to actions a government is not willing to take today.

Both loom large for the UK’s new chancellor and prime minister, with a maximum two years left of such mandate as they have.

Here is the greatest paradox. In budget policy the UK is in a sense freer than it would have been as a member of the EU, let alone of the euro. But is it Britain or the members of those blocs who are under the most intense pressure to squeeze their public finances dry?

The ECB’s instrument against disorderly bond market movements has so far been received with less nervousness in markets than the Bank of England’s struggles to explain why it wanted to buy and sell gilts at the same time.

Interest rate and energy price increases are making things difficult for everyone, but it was the UK that this autumn lost the faith of investors.

And while people have long worried about self-fulfilling funding crises for high-debt euro zone governments, it was UK sovereign bonds that suffered a disorderly sell-off this time round.

[ Jeremy Hunt unveils £55bn UK fiscal squeeze ]

The Bank of England’s freedom is supposed to be superior to the constrained European Central Bank. But the ECB’s instrument against disorderly bond market movements has so far been received with less nervousness in markets than the Bank of England’s struggles to explain why it wanted to buy and sell gilts at the same time.

So far, the EU’s governance is buying it room for manoeuvre. And Brexit Britain is testing an old philosophical debate over what constitutes freedom: the lack of constraints or the most effective self-regulation of one’s passions. – Copyright The Financial Times Limited 2022