From fiscal rules to fiscal traffic lights : rethinking the UK fiscal framework

The central contention of this report is that the UK fiscal framework has some desirable features but is not delivering good outcomes. We are in a bad equilibrium. The UK's fiscal framework is based around a set of pass-fail, numerical fiscal rules. The fiscal debate is overly fixated on the amount of 'headroom' the government has against the most binding of those rules. The system incentivises the government to operate with the smallest amount of 'headroom' possible, with policy often fine-tuned according to the central point estimate of a highly uncertain forecast from the Office for Budget Responsibility. When the forecast improves, any additional 'headroom' is typically spent; when the forecast worsens, Chancellors of all political hues are adept at meeting the letter of the rolling fiscal targets by promising spending cuts or tax rises for future years - or the rules simply get changed. Put differently, the framework and the way it has come to be operated mean that when forecasts move around - as they inevitably do - policy has to respond, often in a rush and with a spurious degree of precision. This does not make for good policymaking, it does not ensure sustainable public finances, and it stretches credulity and credibility with financial markets. We are living through a tough fiscal moment, but it is hard to believe this is the best we can do. This report argues that the UK would be better served by a new framework based around a set of 'fiscal traffic lights', used to monitor performance against broad fiscal objectives and principles set out in a high-profile Statement of Fiscal Strategy at the start of each parliament. The overarching aim would be to create the conditions for better fiscal policymaking and a better fiscal debate while maintaining - or building - credibility with bond market investors. This is a proposal for the medium-to-long term, and not an argument for immediate reform. The current set-up has its shortcomings, but to abandon the current fiscal rules at the present moment would very likely be interpreted by financial markets merely as an attempt by the government to relax its fiscal constraints and borrow more - which is not the point of this proposal. Only from a position of strength and credibility - ideally having delivered a current and/or primary budget surplus - should such a change be considered. In the nearer term, a set of fiscal traffic lights could be developed and operated in parallel with the existing system over the remainder of this parliament, to iron out issues, build understanding, and facilitate a full transition at the point when the fiscal rules next come under review.