The tragedy for Sunak is that things really are getting better

rachel reeves
A change in the debt rule would give chancellor-in-waiting Rachel Reeves more leeway on spending - Hollie Adams/Bloomberg

Anyone who read the International Monetary Fund’s latest “Article IV” assessment of the UK economy might have noticed one rather intriguing suggestion, at least to those of us interested in the minutiae of UK fiscal policy.

This is that the Office for Budget Responsibility’s forecast horizon for its Economic and Fiscal Outlooks be extended from five to ten years so as to better capture the effects of growth-enhancing measures such as public infrastructure spending, changes to taxation and the pressures of an ageing population.

To be clear, the IMF is not advising that the debt rule, which at present requires public debt to be falling as a proportion of national income in five years’ time and which both main parties in next month’s general election have signed up to, be extended from five to ten years. If anything, it suggests this rule be toughened up to require a 75pc probability of being met rather than the present 50pc.

This seems to me to be reasonable. If ever there was a time to be rebuilding fiscal buffers against the next economic shock, it is now, with the economy once more growing and unemployment low.

Even so, the addition of ten-year forecasts would begin to answer persistent criticism from both the political Right and Left that the present fiscal framework is too restrictive, and fails properly to take account of the positive long-term impact on growth and productivity of policy initiatives that can take some years to show through.

The drawback of the five-year rule is that it is overly pro-cyclical, doesn’t fully allow for the dynamic long-term effects of tax and spending decisions, and by encouraging short-term fixes over long-term thinking, reduces policy to technocratic, status quo conformity.

By agreeing to be tied by such rules, chancellors severely limit their freedom of action, sometimes in a counterproductive manner.

The OBR is acutely aware of such criticism, though it is of course possible to argue the reverse case. By providing the illusion of constraint, the rules can serve to reduce the market and political pressures for the degree of fiscal discipline that is actually required, and thereby give cover for persistent deficit spending.

The Saint Augustinian principle of “please make me chaste, but not yet” is allowed to reign supreme. Alternatively, the OBR can provide useful cover for the politicians in doing unpopular things, so its disciplines are not always as resented by chancellors as might be assumed.

Even so, five years is undoubtedly too short a time frame to capture the full “multiplier” effect not just of infrastructure spending, but also changes in the tax system designed to boost business investment, such as the Government’s super deductions regime for corporation tax.

The effect is to deter policy that has an immediate fiscal cost but might in the long run deliver superior growth. It is also plainly absurd for the OBR to assume that changes in tax and spending today have no ongoing impact after five years, as now seems to be the case.

One senses the hand of the OBR’s chairman, Richard Hughes, in some of the IMF’s recommendations. He used to work with the IMF divisional chief responsible for the latest IMF assessment, Ali Abbas. We must assume the two discussed the suggested ten-year forecast at length before sneaking it into Article IV.

Not that either the present Chancellor, Jeremy Hunt, or on current polling his Labour successor, Rachel Reeves, would have any objection. They would surely welcome anything that gave extra leeway.

It is an article of faith on the Left that inadequate government spending and investment reduces demand and slows growth, and that cuts to such spending are therefore counterproductive. Years of low-growth austerity under George Osborne prove the point, the Left insists.

Despite this, Reeves has thought it necessary to nail herself to the cross of the five-year debt rule. That’s part of Labour’s pitch – to appear as fiscally responsible as the Tories, or even more so if possible.

But she’s been quite artful in the way she’s done it. She’s committed herself to balanced budgets, but only on current spending, which theoretically leaves plenty of room for borrowing to invest.

She’s also intimated that she wants to see changes in the way the OBR analyses such spending, giving greater weight to its supposedly growth enhancing characteristics. That’s what Liz Truss wanted too, even if in her case it was the growth inducing qualities of tax cuts she wanted recognised, not spending increases.

Both are right to believe there is something not quite right about the way the fiscal rules operate, in the sense that they lead to highly formulaic analysis which restricts the Government’s freedom to act as it thinks appropriate or according to its democratic mandate.

The rules also tend to dictate the political narrative. Given the commitment to the five-year rule, the next government will have no option but to either raise taxes or significantly cut unprotected spending, says Paul Johnson of the Institute for Fiscal Studies with absolute confidence.

In practice, there is no such certainty. Once the markets are judged to be compliant, the fiscal rules could for instance be changed to allow an easier ride. Or, as I suspect might be the case, economic growth could be higher than expected.

As it is, the economy is outperforming expectations, with living standards once more rising. Interest rates will soon be falling, moreover, reducing the Government’s borrowing costs and raising the Government’s “fiscal headroom”. Or something else may occur to change the picture.

I don’t want to belittle the scale of the challenges facing the next government, but the complaint sometimes heard from Reeves about the “worst economic inheritance since the war” is just cynical expectation management.

In fact, she inherits an economy on a strongly improving trend, with both consumption and investment picking up.

As for the fiscal rules, they are only there for show. The obsession with them overstates their real world significance. Since Gordon Brown first introduced the notion of fiscal rules in 1997, they’ve been changed at least nine times. On virtually all occasions, it has been to accommodate rising debt-to-GDP ratios.

“When times are bad and the economy is hit by a shock, the Government relaxes the target,” says Ethan Ilzetzki, associate professor at the London School of Economics, “but when things get better the Government declares victory and loosens policy.”

This will surely happen again soon into the next Labour government. In the end, all that really matters is that fiscal policy is seen to be credible and the public finances sustainable.

The rest is detail.