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UK Labour’s Fiscal Credibility Rule: Neoliberal Orthodoxy Dies Hard

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Joe Emersberger interviews economics professor Bill Mitchell about the British Labour party’s fiscal credibility rule.

Under Jeremy Corbyn, the UK Labour party has, to an unprecedented degree for party with a real chance at taking office in an industrialized country, embraced a left wing platform. Corbyn’s shadow chancellor (finance minister) John McDonnell has recently provoked headlines like “Labour Party plots overthrow of capitalism” but Mitchell, in a recent meeting with McDonnell and his advisers, saw a troubling unwillingness to confront some neoliberal dogmas. Mitchell hopes grassroots pressure can turn that around.

Joe Emersberger: I was intrigued by a very detailed postof yours criticizing the British Labour party’s fiscal credibility rule. According to the rule, Labour is committed to closing the deficit on day to day spending over five years, and to making sure the government’s debt (presumably its gross debt to GDP ratio) is falling at the end of five years, and that it will only borrow to invest – so only for capital expenditures and not for so called expenses. You’ve criticized that.

Bill Mitchell (WM): Several times since it came out in 2016.

JE: And you met with McDonnell and his team very recently?

WM: I met with John McDonnell and a couple of his advisers in London in October.

JE: In a nutshell what is the big problem with the fiscal rule?

WM: Obviously a rule introduces inflexibility. When the rule is defined in its own terms and what I mean by that is in terms of just other financial aggregates, so in this case a rolling five year window on recurrent spending and revenue, a debt to GDP ratio…

JE: Is that that gross or net debt?

WM: That’s unclear but typically it would be gross. That’s the normal way of expressing these things and I haven’t seen anything in writing, nor did they tell me in person that it was nuanced in any way.

The problem is that when you just define these fiscal aggregates within their own financial terms you’re really losing the purpose and meaning of fiscal policy. The purpose of fiscal policy isn’t to achieve any particular fiscal outcome whether it be a balanced fiscal position, or a deficit of whatever percent or even a surplus of whatever percent. The purpose of fiscal policy as a tool is to advance wellbeing in the economy, to engage in government spending programs which are consistent with its electoral remit, and taxation to manage total expenditure in the non-government sector so that there is space – and what I mean by “space” is real resource space – for the government to basically buy those resources and conduct its programs. Taxation creates that space by depriving the non-government sector of the use of resources.

This is the purpose of fiscal policy. In a cyclical sense – in other words in the variation of economic activity – fiscal policy should play a very important role in being able to offset any fluctuations in non-government spending that would either cause unemployment if it were not offset, or would drive inflation if it were not offset. Fiscal policy has to be flexible enough to allow the government to meet that purpose. If you start imposing rules that are independent of purpose then you are likely to end up not meeting that purpose but also failing to meet your rules.

The example that governments get burned with over and over again in this neoliberal period of fiscal rules, is they say “we are targeting a surplus in the next year or two years”. Of course they go about doing that by cutting discretionary spending programs for example. That drives economic activity down. Tax revenue then falls. Welfare payments rise because there is rising unemployment and the fiscal position typically goes into higher deficit. It’s sort of counterproductive to try to target an aggregate that you don’t have complete control over anyway. That example shows that while the government has discretion over its policy settings the final fiscal balance will depend on the spending and saving decisions of the non-government sector. If the non-government sector cuts its spending and the government does nothing, then it is likely the fiscal deficit will rise anyway because of the fall in tax revenue and rise in welfare payments under current policy settings.

We just don’t need inflexible rules that are not related to the public purpose of fiscal policy.

JE: At one point in Labour ‘s fiscal rule documentit says that everyone’s personal finances are analogous to government finances: “everyone knows that if you’re putting the rent on the credit card month after month things need to change.” Why are they afraid to challenge, rather than invoke, such a dumb analogy?

WM: This might be a dumb analogy and it is dumb once you understand it, but as I’ve said for years and years, for decades, this is one of the........

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