Fiscal rules are entirely unimportant except they’re vital

This might not be the most accurate, in detail, piece of economics ever but it is still a good guide:

Rachel Reeves’s “opportunistic” attempt to rewrite Britain’s fiscal rules ahead of the Budget risks causing a surge in interest rates, a leading think tank has warned.

The Institute of Fiscal Studies (IFS) said any move to alter the Chancellor’s self-imposed fiscal rules “would not be without risks”, which comes ahead of her maiden Budget in October.

Ms Reeves is considering the change to unlock up to £50bn for spending on large-scale projects such as roads and housing, as the Treasury seeks to “count the benefits of public investment and not just the costs of it”.

It’s wholly true that to borrow to invest in an asset which will then produce a return is different from borrowing to pay current expenses. Creating that weapon that will fully keep the French at bay for a century will pay dividends in a manner that spending to raise train drivers’ wages will not. Therefore lenders (or if we wish to adopt the rather fanciful claim of some on the foolish left, those who wish to partake in the savings opportunity being offered by government) will be happy with a higher multiple of cashflow available to service the debt if it’s being invested not splurged. This is why you can get a mortgage for 4x income and not an overdraft for beer consumption for 4x income.

Switching about the fiscal rules to make this more obvious makes little to no difference - it’s just playing accounting games and lenders are immune to that sort of nonsense for they make their own estimations. Borrowing to invest (but not to “invest”) will not spook the markets.

However, fiscal rules are also vital. Not particularly for any economic reason but for reasons of political economy. Taxing is hard, spending is joyous. Therefore politicians have a propensity for spending the (insert word of choice here) out of everything and not taxing to cover their joy. Fiscal rules are a self-imposed constraint upon this political fact. Changing the fiscal rules is the statement that we’re not going to accept this self-imposed constraint. Lenders (or, to taste, savers with the government) will therefore likely ask for a little more interest - or more accurately, only lend (save) if they are offered more interest - if the fiscal rules are changed for what look like political reasons. Because spending the (insert word of choice here) out of everything becomes more likely along with the future debt and interest burdens, an increase in inflation from the stimulatory effect upon the economy and so on.

Fiscal rules don’t matter except they’re vital. Odd but true.

We also have a stock of approaching £3 trillion in government debt - before we even start to think about pensions obligations and so on. A change of 1% in the interest rate demanded (or, the interest rate at which people will save with the government) thus costs £30 billion a year. A 1% change in the rate on gilts would be a huge change and is unlikely from the being discussed tweaks to the fiscal rules. A belief that the current government really was going to spend the (insert word of choice here) out of everything could change it by that and more. It’s also true that that higher rate would only kick in as the stock of gilts matured and was reissued - but the long term effect would still be there.

A tweak to produce £50 billion more to spend now at the cost of £30 billion a year forever doesn’t look hugely clever if we’re honest about it. Even if that £50 billion is invested, not “invested”.

No, we’re not saying that tweaking the rules is going to move gilts interest by a full percentage point. That’s a deliberately exaggerated example of the logic, nothing more. But insisting upon spending the mortgage on beer is likely to increase the interest that has to be paid all the same. Of course, of course, the current po-faced lot won’t spend the cash freed up on anything so useful as beer. But we really do still face this problem or point. Borrowing to invest in productive assets has its merits. So, interest rates will move by however much the lenders believe the money will be spent upon productive assets and not beer, train drivers’ wages and so on.

And do recall, money is fungible. So it’s not actually how much of the extra borrowing is invested (not “invested”). The view is going to be about how much of the average £ is invested not “invested”.

You see the problem?

Tim Worstall