In defence of Labour's fiscal rule

Richard Murphy and James Meadway have been debating Labour���s fiscal credibility rule. Richard says it commits Labour to austerity; James says it doesn���t. I agree with James.

Let���s take Richard���s strong point. As I understand it, this is that public borrowing is the counterpart of private sector saving. The fact that a government deficit today co-exists with record-low bond yields tells us that the deficit is due to a global savings glut (or investment deficiency): accounting identities tell us that the counterpart to government borrowing is the UK���s current account deficit, which is another phrase for the rest of the world���s excess of saving over investment.

Given that post-Brexit uncertainty is causing firms to delay spending, it���s possible that the global savings glut will soon be also accompanied by the return of a significant corporate sector financial surplus, which would increase government borrowing.

Richard���s right that a fiscal rule which commits the government to fiscal balance in a world where the private sector wants to save would depress the economy and be self-defeating ��� just as Osborne���s austerity was.

However, there are three safeguards against this. The biggest is the knockout clause ��� that the rule will not apply when interest rates are at the zero bound. As John McDonnell said:

We will reserve the right, for as long as monetary policy is unable to undertake its usual role due to the lower bound, to suspend our targets.

A world in which the private sector is saving massively will be one in which rates are near zero, so the rule won���t apply.

Secondly, the same savings glut which gives us big public borrowing also gives us ultra-low bond yields. These mean that McDonnell���s promise to reduce the ratio of government debt to (trend) GDP is compatible with big borrowing. The maths of debt sustainability tells us that with index-linked yields at minus 1.4% and assuming trend growth of 2% any primary deficit of less than 3% of GDP would reduce the debt-GDP ratio. As the government is currently running a deficit of 1.1% of GDP, this implies that a significant fiscal easing is compatible with the fiscal rule.

Thirdly, policy-makers have another tool to support the economy: helicopter money. As Martin and Eric have argued, central banks can simply write people cheques.

I suspect, therefore, that Richard is wrong to say that Labour���s fiscal rule commits it to austerity. It doesn���t. Right now, it would be entirely consistent with reflationary policies.

All this said, he raises a good question. The fact that yields on top-quality government bonds around the world are at record lows tells us that there is an acute shortage of safe assets ��� a shortage which is doing terrible damage to people���s ability to save for retirement, among other things. The obvious solution to this is for governments to simply create more such assets by borrowing. So, why does Labour need a fiscal rule?

One big reason, I think, is political. Labour must establish economic ���credibility���. In the eyes of our asinine media, this credibility requires a plan not for jobs but for the public finances. John McDonnell���s rule does just this without damaging the economy. When you���re faced with a rabid dog, you should throw it a bone.