Richard Murphy and the Fiscal Credibility Rule: a reply

Tax specialist Richard Murphy has offered some comments on John McDonnell’s “Fiscal Credibility Rule”. I thought it’d be worthwhile me responding, not least because Richard’s understanding of both the Rule itself, and the economics involved, appears to be deficient. The debate on the UK’s fiscal policy has been blown open by the failure of former Chancellor George Osborne’s own policy, but it’s preferable to conduct such a discussion with a degree of clarity. Richard’s blog, unfortunately, reflects a significant degree of confusion over the points under contention.

Some of that confusion is over a fundamental political question. To be clear, Labour is now an anti-austerity party, opposed to the rundown and break-up of our public services. The Fiscal Credibility Rule is entirely compatible with that. Richard is wrong to claim otherwise. Likewise, Owen Jones is wrong to claim that John McDonnell is offering Ed Balls’ fiscal policy. He absolutely is not. He is opposed to cuts.

John presented the Fiscal Credibility Rule back in March, just ahead of George Osborne’s disastrous Budget. It’s based partly on a 2014 academic paper by Prof Simon Wren-Lewis, and Jonathan Portes, which sought to draw up the best possible fiscal rule for a government to follow. (Simon has also written, in less technical language, about the Fiscal Credibility Rule and the thinking behind it on his blog.) The Rule was originally presented and discussed at a meeting of the Economic Advisory Council back in late 2015. Richard had previously provided us with some useful guidance on tax issues, but, knowing that he takes an interest in wider policy, myself and another advisor to John had a good discussion with him about the Rule ahead of making any announcements. He blogged his support for the Rule later.

The Fiscal Credibility Rule says that government will bring day-to-day spending into line with taxes over a five year rolling time period. It says government will seek to reduce the government debt relative to potential GDP by the end of Parliament. It makes the Office for Budget Responsibility report to Parliament to add accountability. And, in a critical innovation, it grants a licence to the Monetary Policy Committee to determine that when conventional monetary policy no longer operates properly (at the “lower bound”), the MPC can decide to suspend the Rule. This is essential at a time when there is much talk of negative interest rates, and perhaps an extension of Quantitative Easing. It means a government won’t find itself with its hands tied if it needs to move fast to keep the economy going. (Paul Mason explores some of the implications of this knock-out clause here.)

What the Rule offers is a framework for making decisions about taxation and spending. It says that a government sticking to the Rule will bring taxes and day-to-day spending into line with each other, but will not do so in a way that damages the economy or public services. It also does not restrict government’s inability to invest, in stark contrast to George Osborne’s indefensible restraints on investment. What the Fiscal Credibility Rule does not do, however, is lay out a plan for austerity. Nothing of the sort: as Simon Wren-Lewis says, the Rule means at present “that pretty well all of the additional austerity Osborne has detailed since the election is unnecessary.” Steady economic growth can supply the additional tax revenues necessary to remove the deficit without the pain of spending cuts.

Of course, a government operating in the framework provided by the Rule could, if it wanted to, carry out George Osborne’s spending cuts. They would fit inside the framework. But the government would not need to. And as John McDonnell and Jeremy Corbyn have repeatedly said, Labour is now an anti-austerity party. In stark contrast to previous Labour Chancellors and Shadow Chancellors, John’s opposition to spending cuts absolutely clear. He will not be offering to, for example, “cut deeper than Thatcher”. Nor would he suddenly collapse, before the next election, into meekly accepting the Tories’ spending cuts. John has always argued, correctly, that austerity is a political choice. George Osborne chose to make the cuts. Labour’s political choice now is to oppose spending cuts. The dividing line could not be clearer.

None of this is apparent from Richard’s blog. Quite the opposite: he misunderstands the Rule, he misunderstands its consequences, and he misunderstands the wider economic theory. I’ll go through this step by step.

First, the Rule does not include, as he claims, a “clear political commitment to austerity”. It includes nothing of the sort. Labour’s “clear political commitment” is to oppose spending cuts. The Rule allows this.

Second, the Rule does not call for a balanced budget “over the cycle”. As Simon Wren-Lewis and Jonathan Portes’ original paper makes plain, fiscal rules that seek to balance spending “over the cycle” are prone to meddling with by governments: who, after all decides where the business cycle starts and finishes? There is no fixed definition of the business cycle, so the temptation for a government to adjust where it claims the cycle is, and therefore alter its spending, is very great — as Gordon Brown discovered. Quite deliberately, then, the Fiscal Credibility contains absolutely no reference to the business cycle, instead using a rolling five year target for the deficit. Richard does not appear to understand this.

Third, the Rule does not result in a “commitment to running a current government surplus on occasion”. Richard means by a “government surplus” that government will sometimes end up spending less than it receives in taxes. But this has nothing to do with the Rule: if there is an unexpected boom, leading to more taxes coming in than government planned to spend, a surplus will appear. But this has nothing to do with government. It’s about what the rest of the economy is doing. Under these circumstances, a government following the Rule would be able to increase its day-to-day spending, to bring it back into balance. This is the exact opposite of what Richard implies.

At the most basic level, Richard appears not to have understood what the Rule says. It’s quite hard to know what to do with this confusion about the central issues. Either Richard does not understand the Rule — in which case I must bear some responsibility, having tried to explain it to him. Or he does understand it, but is ploughing on regardless, knowing he is misleading his readers.

Or, as I suspect, it is neither — that, instead, his desire to comment on an issue has run ahead of his willingness to study it. What else, for instance, could have led to his strange claim, in the same blog, that a 2014 Bank of England paper on money creation tells us that “the government can always print money, instead of borrow”. It does not; I’m not entirely sure he’s read the paper he’s citing. A similar misunderstanding seems to arise from his description of Theresa May as having adopted “People’s Quantitative Easing”. She appears to have only mentioned borrowing more money. Unless People’s QE was always just a new name for good old-fashioned debt-financed government spending, it’s hard to know how this kind of confusion could arise.

Likewise, Richard appears to believe that opposing neoliberalism is identical to supporting fiscal deficits. It is not; if it was, Presidents George W. Bush and Ronald Reagan, who intentionally ran eye-watering deficits, would be heroes of the anti-neoliberal opposition. The neoliberal period from the late 1970s has been one of persistent deficits. The question of a government’s fiscal stance is different to the core neoliberal questions of the degree to which markets are liberalised and corporations allowed to determine economic outcomes.

Richard concludes by conceding the main point that some framework — a rule, even — is required for fiscal policy. In this he is correct, particularly for a government seeking to transform how an economy operates. There are tens of thousands of people being brought together by Jeremy Corbyn’s campaign to make that transformation happen. It is a shame Richard no longer wishes to be there with them.

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Economist and writer, @meadwaj

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