The UK’s fiscal rules, designed to ensure responsible financial management, have become increasingly restrictive, particularly at a time when significant public investment is urgently needed.
The Labour government has committed to two main fiscal rules: balancing the current budget, so day-to-day costs are met by revenues, and ensuring that public debt falls as a share of GDP over a five-year horizon. While these rules have provided a framework for fiscal discipline, they risk constraining investment in critical infrastructure, public services, and green energy. As the Chancellor prepares for the upcoming budget, there is a strong case for revisiting the UK’s fiscal framework to align it with the country’s long-term economic needs.
At the heart of the UK’s fiscal framework is the measure of public sector net debt (PSND), which includes liabilities linked to the Bank of England’s operations, such as its quantitative easing (QE) programme. These liabilities inflate the government’s debt figures and reduce fiscal flexibility. By using PSND as the primary measure, the government effectively ties its hands, limiting the scope for public investment that could stimulate long-term growth.
There is growing support for changing the debt metric to public sector net debt excluding the Bank of England (PSND ex BoE). This measure, which would exclude the liabilities generated by the Bank’s interventions, could unlock an estimated £16 billion of additional borrowing capacity. Influential organisations, such as the Institute for Public Policy Research (IPPR), and economists like Lord Jim O’Neill, have advocated for this shift, arguing that it would free up fiscal space for much-needed investment in infrastructure, education, and green energy.
Several countries have adopted more flexible fiscal strategies that balance fiscal discipline with the need for public investment. For instance, Germany excludes the liabilities of state-owned development banks from its fiscal targets, allowing these banks to leverage their balance sheets for investment without directly impacting the government’s debt metrics. Similarly, Sweden and the Netherlands take a more medium-term approach to fiscal planning, focusing on sustainable public expenditure rather than rigid short-term debt targets.
Adopting a more flexible debt measure, such as PSND ex BoE, would align the UK with these countries, giving the government room to invest in projects that boost long-term productivity and growth. Infrastructure investment has a high multiplier effect, generating returns that far outweigh the initial cost. By loosening fiscal rules, the government can lay the groundwork for future economic prosperity without compromising fiscal responsibility.
The UK is currently grappling with stagnant productivity, deteriorating public services, and an urgent need for investment in green energy and infrastructure. Public investment in these areas is crucial for addressing the country’s long-term challenges, including the transition to a low-carbon economy and the need to improve health, social care, and education services. However, under the current fiscal rules, the government faces a significant constraint on its ability to finance these investments.
By shifting to a more flexible debt metric, the government could increase investment without breaching the letter of its fiscal rules. This would not only improve infrastructure but also stimulate economic growth by increasing demand, boosting productivity, and expanding the tax base. Over time, these investments would help reduce the debt-to-GDP ratio, supporting fiscal sustainability in the long run.
Moreover, investment in green energy and infrastructure is particularly beneficial for long-term growth. Green investments have higher multiplier effects than their carbon-intensive counterparts. These investments also help future-proof the economy, making it more resilient to the impacts of climate change and the transition to a low-carbon world.
One of the main concerns about altering fiscal rules is the potential reaction from financial markets. Changing the debt metric could be seen as a softening of the government’s commitment to reducing debt, leading to higher borrowing costs. However, if managed transparently and aimed at productive investment, such a change is unlikely to spook the markets. The International Monetary Fund (IMF) has supported more flexible fiscal rules that prioritise investment over short-term debt reduction, recognising that investment in infrastructure and green energy can enhance long-term economic stability.
The key to maintaining market confidence is clear communication. The government must present any changes to the fiscal rules as part of a broader strategy for sustainable growth, rather than a loosening of fiscal discipline. By demonstrating that the additional borrowing will be used for productive investment, the government can reassure markets that it remains committed to fiscal responsibility while also addressing the country’s long-term economic challenges.
The UK’s current fiscal rules, while well-intentioned, have become overly restrictive in the face of the country’s urgent need for public investment. By adopting a more flexible debt measure, such as PSND ex BoE, the government can unlock fiscal space for critical investments in infrastructure, green energy, and public services. These investments are essential for boosting productivity, driving long-term growth, and addressing the challenges of climate change.