With Chancellor Sunak offering new direction for the macroeconomy next week, some friends and I rose to the challenge in the March Budget that “it’s important that we update our fiscal framework to remain at the leading edge of international best practice.”
The paper is in two parts. The first recalls the traditional debt sustainability “rules” were evolved in the 1980s and 1990s in a period when theory relied on the assumption that i > g. This was reasonable then, but is unrealistic today for reasons noted recently.
Instead, we suggest the overall fiscal stance should lean on the OBR’s assessment of debt sustainability, relying on a projection of the overall interest rate paid on government debt relative to nominal growth.
If the interest on government debt, taken from financial markets for future coupons, is below the projected nominal growth rate, then fiscal “consolidation” can be moderated. But if the average interest rate drifts higher, the primary balance would have to adjust.
Armed with this “independent” analysis, the overall fiscal envelope would therefore be determined and within which the government would function.
The second part of the paper examines historical cases where the UK faced seemingly insurmountable debt burdens. It suggest that we have been here before, and there is no need to panic.
In other words, the fiscal rule needs to be modified to the needs to private saving, and not pre-empt some unlikely debt crisis that exists only in the minds of politicans.