Outlook So the moment has finally arrived. After more than11 years of insisting that its fiscal rules provided the foundations for an indestructible edifice of economic stability, the Government has accepted the inevitable. Alistair Darling may not have put it in quite these terms last night, but his assertion that "as markets change, so should policy" was about as frank an admission as you will get from the Chancellor that he no longer feels constrained by either the sustainable investment rule or the golden rule.
There is no way to gloss over the political humiliation of this U-turn. David Cameron used Prime Minister's Question Time yesterday to highlight the collapse of such a central tenet of Labour's economic policy, and there will be plenty more attacks to come.
Rightly so. For budget after budget, Gordon Brown and, latterly, Mr Darling, have droned on and on about their beloved fiscal rules, boring us rigid with the same self-righteous claims about prudence. Now the pair of them have to eat their words and the Tories would be fools to miss the chance to ensure every last morsel sticks in their throats.
Moreover, Mr Cameron's main line of attack is difficult to counter. The figures show that, as the Conservative leader contends, the Government made hay while the sun shone with little thought for the future. Debt, as a proportion of GDP, began rising in 2002 and reached an estimated 37.1 per cent last year, just as the possibility of downturn began to loom large. The precious wriggle room that a bit more forwardplanning might have delivered – the sustainable investment rule sets a maximum permissible figure of 40 per cent – is thus in desperately short supply.
All the same, let's not go overboard. There is nothing sacrosanct about 40 per cent – it's an arbitrary figure plucked out of the air 11 years ago. Great Britain will not suddenly sink beneath the waves just because we breach the limit (indeed, we already have, since economists put national debt at 43.4 per cent of GDP in September).
Moreover, the Prime Minister's defence against the Conservative line is a valid one. For it is true that on the basis of international comparisons, our borrowing looks relatively modest. We now expect to see debt rise to 45 or 50 per cent (assuming bank liabilities stay off the books). The comparable figure for both Germany and France, for example, is around 65 per cent. For Italy, it's above 100 per cent. Don't even ask about Japan.
Mr Brown is also entitled to attack Conservative assertions that tax cuts would be a more immediate fiscal stimulus to the economy than the public spending initiatives the Government now plans to bring forward. The latter is at least capital investment and therefore within the rubric of the golden rule, that the government should only borrow to invest.
What's important now is that we do not go from the sublime to the ridiculous. The Government may be scrapping one set of particularly rigid fiscal rules, but that should not be a licence for a free-for-all. Mervyn King, the Governor of the Bank of England, made exactly this point in the summer Inflation Report. Dumping the fiscal rules would not be a problem, he implied, as long as they were replaced with a coherent medium-term framework under which fiscal policy would instead operate. This is the challenge for Mr Darling now – to explain how he sees such a framework operating, and how it would work alongside monetary policy.
In last night's Mais Lecture, the Chancellor didn't offer such a vision, though he has promised to say more when the pre-Budget report is published in the next month or so.
The prolonged absence of such clarity would give rise to real economic danger. For example, with the Government throwing money at the economy through fiscal policy, and the Bank of England doing the same via lower interest rates, we'd end up back in bubble territory. Equally bad, but more painful in the short term, would be a situation where the Bank felt compelled to use monetary policy as a brake against the Government's fiscal recklessness.
One other thought. Since MrDarling is already eating humble pie, what about helping himself to an extra slice and accepting the Tories' calls for an independent auditor of whether or not the Government is meeting the fiscal rules it sets itself? It would help put an end to the tedious debates about when theeconomic cycle began and ended. Such an authority would also beideally placed to make sure that medium-term framework does notgo the same way as the fiscal rules.
There is no shortage of bodies that could perform such a task. The National Institute of Economic and Social Research or the Institute for Fiscal Studies, for example, already undertake very similar work to the US body that independently audits government policy, the National Bureau of Economic Research.