1. Money

    Jagjit S. Chadha

    It’s time for a new fiscal framework

    It's time for a new fiscal framework
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    The publication of the OBR’s fiscal risks report helps us understand some of the pressures on fiscal policy arising from the pandemic, climate change and changes in the costs of debt. But it should not be treated as an excuse not to understand that fiscal policy’s main responsibility is to manage risk rather than being subject to it.

    Rules rather than discretion have been the dominant paradigm in macroeconomic policy since the failures of the 1970s. Such rules should be transparent and widely understood and thus allow people to behave in manner consistent with their attainment. They should also allow us over time to measure the effectiveness of policy. Most importantly perhaps their attainment matches the people’s idea of what sensible policy should be. These ideas have so permeated monetary policy making that it is hard to imagine the world of mystique that preceded it. Accordingly, there continues to be no great concern about the continued targeting of price stability. And yet fiscal rules have failed. The ones we have written down to not meet the challenges of society and are then changed as they are broken. Rather than helping the economy get a better place, the fiscal rules they have prevented a focussed debate on the objectives and responsibilities of fiscal policy.

    What we need now is to break the mystique about fiscal policy, open-up decision making to a more transparent dialogue about alternatives and on impact of policy over the longer run. Some aspects of our fiscal frameworks have involved worthwhile and probably enduring innovations, such as the 2010 establishment of the Office for Budget Responsibility as an independent forecaster. And yet the stance of fiscal policy in the Long Expansion of 1992-2007 and in the period following the global financial crisis of 2007-8 got much wrong with policy at first too loose and then too tight. This in part the fault of the political imperative to ensure policy meets the needs of the electoral cycle rather than those of the economy, which move to a quite different beat. Admittedly, policy has flexed in response to economic news with the obvious examples of the financial crisis and Covid. But there is no formal process by which we can judge whether the resulting policy has hit the right note. And so, there is a need for careful re-framing of both the transparency and accountability if we are to tackle the deep-seated economic problems revealed by EU exit and the Covid-19 pandemic.

    Fiscal policy is a complex, multifaceted attempt by the state to fill gaps in the market economy and encourage the private sector to uncover productive practices. It operates over a longer horizon than monetary policy, a different frequency but has the capacity to affect directly household and regional incomes. Of course, fiscal policies must be both sufficiently flexible to respond to changing circumstances but also guided by more formal scrutiny of the outcomes. Too much fiscal policy operates by the smoke and mirrors of political surprise and partial leak designed to manage the day-to-day news cycle rather than the more sober manner of timetabled meetings and clear, minuted decisions with the focus on the impact of policy and the assessment of alternatives. In effect we are lacking a mechanism of fiscal policy evaluation within the overall context of our economic progress – because hitting or rather missing an arbitrary deficit target is neither here nor there.

    There needs to be a structured and fixed timetable for our two fiscal events per year. With pre-budget periods kick started by the publication of a key issues and judgements report. There needs to be more explanation of the stance of fiscal policy over the longer-term planning horizon and an outline of the impact of alternate fiscal choices. Parliamentary scrutiny and a more normative independent assessment of the choices must be built into the flow of news. A fiscal council can actually provide counsel. And we must return the world when leaks or previews of fiscal plans were sufficient to cause immediate exit from office. The objective of fiscal policy is not to manage the news cycle but to manage the economy. The final part of our jigsaw is to enshrine analysis that explains the impact of policies at the household and regional level and to assess the socio-economic outcomes across the country and the devolved nations. If we are to avoid the mistakes of the past, which have led to a sharp relative decline and increasing inequalities, we need to start exposing more carefully and fully the progress of the nation at our fiscal events.

    Jagjit S. Chadha is the Director of the National Institute of Economic and Social Research