Britain currently has two emergency fiscal rules. There is a commitment, roughly speaking, to eliminate the structural deficit and to start shrinking net debt by 2015-6. These short term measures are designed to deal with the current debt crisis. If the government meets its objectives, the question then becomes, 'what next'?
Deficits are not inevitable. In the eighty-three years between 1816 and 1899, the UK ran a deficit greater than 1% of
Some kinds of flexibility are more than important than others. The overall deficit is made up of two components. One portion of the deficit is caused when, in a recession, the cost of benefits increases and the revenue from taxes falls. This imbalance corrects itself when the economy returns to normal. The second part of the deficit is the structural deficit. This part is caused by the long-term shortfall between tax revenue and spending. This remains even when the economy is fully healthy. Governments often run a structural deficit to boost the economy with greater spending and lower tax. Unfortunately, this type of discretionary fiscal policy has a poor track record. Demand management can be left to the central bank, providing a country has its own currency.
A modern version of the balanced budget rule can be seen in the 'debt brake' rule adopted by Switzerland in 2001. Gross Swiss debt moved from around 38% of
Britain should copy the Swiss. Once the structural budget has been balanced, we should pledge to keep it that way with our own debt brake. Of course, no fiscal rule can perfectly predict the future. However, they can counter our focus on the short term. In good times, we should be balancing the budget and paying down the debt. That way we can be better protected when the next crisis arrives.
Kwasi Kwarteng is the co-author (with Jonathan Dupont) of Binding the Hands of Government: a credible fiscal rule for the UK.