Why Rachel Reeves’ New Fiscal Rules are the Right Choice

By Nicholas Griffiths

On the 24th of October, as a prelude to the Autumn budget, Rachel Reeves announced that Britain's fiscal rules would change. Moving from a Public Sector Net Debt (PSND) approach towards a Public Sector Net Financial Liabilities (PSNFL) approach, thus marking the ninth change to British fiscal rules in the last 16 years.

The old PSND approach measured debt based on the amount of liquid financial assets (assets) versus deposits and currency and bonds and loans (liabilities). Which required that the debt as a percentage of GDP falls within the fifth year of the forecast period and that net borrowing should not exceed 3% of GDP within the same period. However, in light of the £22 billion blackhole found within treasury audits and not shared with the office for budget responsibility, there appeared to be little legroom for the Labour manifesto promises of increasing funding for public services, of greater investment in green energy, and of eventually raising defence spending to 2.5% of GDP.

The new PSNFL approach redefines debt to include illiquid financial assets and liabilities, such as student loans or equity holdings within the Great British Energy national wealth fund. But, in some ways, the new approach is stricter, as the new rules will eventually require that this measure of debt falls within the third year of the forecast period and they limit the surplus/deficit to 0.5% from a balanced budget within the third year of the forecast period, encouraging stability while discouraging harsh austerity measures.

As a result, Rachel Reeves managed to free up £49.1 billion in headroom, which helped to fund around £33 billion in investment (according to the Office for Budget Responsibility’s (OBR) Economic and Fiscal Outlook report), and therefore helping to fix the foundations of the economy and secure long-run growth. Although the changes and increases in borrowing did spark a climb in gilt yields, it was far from a crash, as seen with the Lizz Truss mini-budget, as the promise of sustainable investment-led growth constrained by the fiscal rule appeared to appease the bond market.

Nevertheless, this does not mean the new fiscal rules are without issue. For starters, in some ways, the new rules betray the purpose of fiscal rules as a gauge of the government's ability to repay its debt, because illiquid assets cannot self-evidently be quickly liquidated for repayment. Moreover, the measurements of debt do not even account for the physical assets such as infrastructure in energy and transport, that are needed to spark Britain's growth. The narrow time frame also leaves little room for the long-run effects on growth from these assets, with research from the OBR finding that only a fifth of the gains in output from public investment occur within the first five years.

But despite these theoretical flaws, overall, the fiscal rules represent a positive direction for the new Labour government, because they still manage to provide the headroom to address the struggling state of the economy, whilst avoiding calamity in the bond markets like the mini-budget of 2022, with an assurance that the debt is still sustainable despite increased borrowing.