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When the Labour party took power last July, UK Prime Minister Sir Keir Starmer said that his government would promote economic “stability”. Yet its approach to managing Britain’s public finances has so far been rather haphazard. After chancellor Rachel Reeves left only a slim £9.9bn headroom against her main fiscal rule to balance the current budget, updated economic forecasts forced her into making £14bn in hasty spending cuts to restore the buffer at March’s Spring Statement. In recent weeks, long-term UK gilt yields have pushed higher. To avoid breaking Reeves’ rules, economists now project that further cutbacks, or revenue-raisers, will be necessary at the Autumn Budget.
Britain’s fiscal fiddling has come to the attention of the IMF. On Tuesday, in its annual health check of the UK economy, it recommended “refinements” to the UK’s fiscal framework to obviate the frequent tweaking. The government should heed its advice. Spending plans ought to adapt to substantive changes in the interest rate, inflation or growth outlook. But there is a balance to be struck. Regularly changing departmental budgets and taxes undermines the clarity that households and businesses need to plan ahead. Quick adjustments to meet fiscal rules also raise the risk of bad policymaking.
Reeves’ allies insist that the chancellor will not use the next Budget to junk the fiscal rules she put in place last October. That is wise. Stable spending limits are necessary to instil discipline across government departments. Earlier this year, the government also sensibly passed a “Charter for Budget Responsibility”, which enshrined the importance of independent assessments by the fiscal watchdog and Labour’s campaign promise to move to only one “major” fiscal event per year. Yet even that did not stop the government from making hefty last-minute cuts to welfare spending in March, ahead of the main Budget planned in the autumn.
How can the chancellor avoid fiscal tinkering in the future? First, she ought to maintain a higher buffer against her spending rules, particularly during periods of heightened economic uncertainty. When bond yields and growth forecasts are volatile, small headrooms are liable to be eroded quickly. This piles pressure on the government as investors speculate over the need for future cuts and tax rises. Ideally, greater headroom rather than hurried policy tweaks would absorb the brunt of shifts in the economic forecasts.
Second, the government can make improvements to how the policymaking process interacts with the Office for Budget Responsibility’s forecasts. For instance, the chancellor could place less emphasis on the fiscal watchdog’s single-figure estimates of the headroom, and instead calibrate its buffers according to confidence bands around the fiscal watchdog’s projections. This reduces the risk of economic policy being overly influenced by inherently uncertain forecasting assumptions.
Another option is for the fiscal rules to be assessed only once per year at the Budget. This would reduce pressure on the government to make policy changes at its Spring Statement. That said, any changes here must consider the important role the OBR’s forecasts play in providing independent information to financial markets about the public finances. Uncertainty can foment self-fulfilling concerns about fiscal sustainability. Better yet, the government can make clear that small breaches of the fiscal rules do not require policy changes outside of the main fiscal event.
Labour has made improvements to Britain’s fiscal framework. A greater emphasis on the current budget creates more room for the government to borrow to invest in raising Britain’s lacklustre productivity. Its charter also enshrines the importance of the OBR. The government should persevere with its rules, but change the way it stays within in them.
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