Facts and Spin about Fiscal Policy under Gordon Brown

Below is a chart of UK net debt to GDP from the mid 1970s until the onset of the Great Depression. This post is about the right hand third of this chart, from 1998 to 2007, which was the period during which Gordon Brown was Chancellor. 

UK Net Debt as a Percentage of GDP (financial years) – Source OBR

In general looking at figures for debt can give you a rather misleading impression of what fiscal policy is doing, particularly over short intervals. However, having finished trawling through budget reports and other data for a paper I am writing, I can safely say that this chart tells a pretty accurate story. (For those who cannot wait for the detail that will be in my paper, there is an excellent account by Alan Budd here.) In the first two years of his Chancellorship, Brown continued his predecessor’s policy of tightening fiscal policy. The budget moved into small surplus, so that the debt to GDP ratio fell to near 30% of GDP. Policy then shifted in the opposite direction, with a peak deficit of over 3% of GDP, a period which included substantial additional funding to the NHS. The remaining five budgets were either broadly neutral or mildly contractionary in the way they moved policy, but as this was starting from a significant deficit, the net result was a continuing (if moderating) rise in debt.

Why was fiscal policy insufficiently tight over most of this period? Despite what Gordon Brown said at the end of his term, I do not think this had anything to do with the business cycle. In one sense there is nothing unusual to explain: we are used to politicians being reluctant to raise taxes by enough to cover their spending, which leads to just this kind of deficit bias. However this should not have happened this time because policy was being constrained by two fiscal rules designed to prevent this. So what went wrong with the rules?

The first answer is in one sense rather mundane. The rules, as all sensible fiscal rules should, tried to correct for the economic cycle. However, rather than use cyclically adjusted deficit figures, Gordon Brown’s rules looked at average deficits over the course of an economic cycle. That allowed Brown to trade off excessively tight policy in the early years against too loose policy towards the end, and still (just) meet his rule. As we can roughly see from the chart, debt ends up about where it started under his stewardship, which also roughly coincided with a full cycle.

Was this intended? The answer is to some extent not, which brings us to the second reason policy was too loose, and that is forecast error. One of the striking things about reading through the budget reports is how persistent these errors were. Outturns seemed always more favourable than expected over the first part of this period, until they became persistently unfavourable in the second. The former encouraged forecasters to believe higher than expected tax receipts represented a structural shift, and they were reluctant to give up that view in the second period. Unlucky or an aspect of wishful thinking that is often partof deficit bias?

To their credit, the current Conservative led government learnt from both these mistakes. Most notably, they set up the independent Office for Budget Responsibility with the task of producing forecasts without any wishful thinking. In addition their fiscal mandate is also defined in terms of a cyclically adjusted deficit figure, which does not have the backward looking bias inherent in averaging over the past cycle. Their mistakeis in trying to meet that mandate when the recovery had only just begun.

What this chart does not show are the actions of a spendthrift Chancellor who left the economy in a dire state just before the Great Recession. He stopped being Chancellor with debt roughly where it was when he started, and a deficit only moderately above the level required to keep it there. The spinthat our current woes are the result of the awful mess Gordon Brown left the UK economy in is a distortion based on a half-truth. The half truth is that it would have been better if fiscal policy had been tighter, leaving debt at 30% rather than 37% when the recession hit. The distortion is that the high deficit and debt when labour left office in 2010 were a consequence of the recession, and commendable attempts to limit its impact on output and employment.