The pound fell and government borrowing costs rose after Keir Starmer’s resignation announcement this morning. As Andy Burnham moves closer to power, there is concern in the financial markets that the government will soon start tinkering with its current strict fiscal rules on borrowing and spending.
What are the fiscal rules?
First introduced by Tony Blair’s Labour government in 1997, and now in their 10th iteration, the fiscal rules are restrictions set by the government to constrain its own decisions on taxes and spending. They are intended to act as a check on politicians seeking to borrow more in the short term, leaving future generations to deal with the consequences. And they also signal to investors and taxpayers a commitment to responsible management of public finances.
Rachel Reeves set out this Labour government’s iteration of the fiscal rules in October 2024. There are three main rules: that the current government budget should be in balance or in surplus by 2029-30; that national debt should be lower as a share of the economy in 2029-30 than in 2028-9, and that some welfare spending must be subject to a (fairly loose) cap.
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The independent Office for Budget Responsibility effectively marks the Treasury’s spreadsheets to see if these fiscal rules are being met. The government is currently on track to do so.
What are the issues with fiscal rules?
While clear fiscal rules can burnish a Chancellor’s credibility and reassure the financial sector, they must be possible to meet – or the markets will punish the government, as Kwasi Kwarteng and Liz Truss found out to their cost.
Chancellors setting reasonable rules can still “be prone to wishful thinking,” said Sean O’Grady in The Independent, permitting themselves huge deficits to be balanced in future years by “unspecified cuts in public spending”. Or they can “lock themselves into a fiscal straitjacket” like Reeves did with her party’s “commitment not to raise income tax, VAT and national insurance contributions”.
The whole approach to a fiscal policy based around “pass-fail” rules needs a “rethink”, said the Institute for Fiscal Studies in February. The “fixation” with “creating ‘headroom’” against rigid rules leads to “dysfunctional” policy-making, and “aggressive ‘gaming’ of rolling targets”. A more nuanced monitoring framework of “fiscal traffic lights” could “reduce the incentive for governments to contort policy in pursuit of a particular ‘headroom‘ number”, and allow for the delivery of “more sustainable public finances”.
What might Andy Burnham do?
During his by-election campaign, Burnham committed to Reeves’ current fiscal rules, after previous suggestions he’d made about changing them caused a bond market wobble. But, with No. 10 now in his sights, there are signs that he could try to give himself more leeway.
He has been “taking advice” from former Bank of England economist Andy Haldane and former Goldman Sachs chair Jim O’Neill, said Bloomberg. Both have been calling for looser fiscal rules for some time. O’Neill has called the constraints “petty and arbitrary”, and Haldane has said the case for changing them is “overwhelming”.
Louise Haigh, the former transport secretary who masterminded Burnham’s Makerfield campaign, has also been vocal in her criticism of Britain’s fiscal framework. In an essay she wrote for a political journal last week, she called for the Treasury’s debt target to “have a longer horizon of about 10 years”, which “would potentially create more room for investment without formally abandoning the rubric”, said Bloomberg.
How the market reacts to any change in fiscal rules would “depend as much on timing and presentation as substance” – and on “the person Burnham appoints as Chancellor”. Reeves is expected to depart with Keir Starmer, and financial markets are waiting to see if she is replaced by someone from the “soft left” of the party, like Energy Secretary Ed Miliband, or from the right, such as former health secretary Wes Streeting.
“In reality, any set of fiscal rules is only really an expression of what investors are prepared to put up with in return for lending Britain money at an affordable rate of interest,” said The Independent’s O’Grady. Financial markets remain both “the unseen authors” and “the ultimate watchdogs” of fiscal rules. And “they have sharp teeth”.
