Fiscal Policy

Introduction

The Government has taken significant steps to strengthen the framework for fiscal policy since taking office. Fiscal policy is now directed firmly towards maintaining sound public finances over the medium term, based on strict rules. Where possible fiscal policy supports monetary policy over the economic cycle. This approach, together with the new monetary policy framework, provides the platform of stability necessary for achieving the Government's central economic goal of high and sustainable levels of growth and employment.

Central to the fiscal framework are five principles of fiscal management:

transparency in the setting of fiscal policy objectives, the implementation of fiscal policy and the publication of the public accounts;
stability in the fiscal policy-making process and in the way fiscal policy impacts on the economy;
responsibility in the management of the public finances;
fairness, including between generations; and
efficiency in the design and implementation of fiscal policy and in managing both sides of the public sector balance sheet.

These principles were enshrined in the Finance Act 1998 and in the Code for Fiscal Stability , approved by the House of Commons in December 1998. The Code explains how these principles are to be reflected in the formulation and implementation of fiscal policy. In addition, the Code requires the Government to set out its fiscal policy objectives and the rules by which it intends to operate fiscal policy over the life of the Parliament.

As set out in Budget 2007, the Government’s fiscal policy objectives are:

over the medium term, to ensure sound public finances and that spending and taxation impact fairly both within and between generations. In practice this requires that:
the Government meets its key taxation and spending priorities while avoiding an unsustainable and damaging rise in the burden of public debt; and
those generations who benefit from public spending also meet, as far as possible, the costs of the services they consume; and

over the short term, supporting monetary policy, by:

allowing the automatic stabilisers to play their role in dampening variations in economic activity (e.g. other things equal, when the economy is growing rapidly there will be higher tax receipts and lower social security payments. These will help to moderate economic upturns and, therefore, stabilise the economy); and
where prudent and sensible, providing further support to monetary policy through changes in the fiscal stance.

The Government has also specified two key fiscal rules that accord with the principles. These are:

the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and
the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.

The fiscal rules provide benchmarks against which the performance of fiscal policy can be judged. The Government will meet the golden rule if, on average over a complete economic cycle, the current budget is in balance or surplus. The Chancellor has stated that, other things equal, net debt will be maintained below 40% of GDP over the current economic cycle, in accordance with the sustainable investment rule.

In setting fiscal policy, the Government takes a deliberately cautious approach. This prudent approach is implemented, among other things, by basing public finance projections on cautious assumptions for a number of key variables including the economy's trend growth rate, levels of unemployment and oil and equity prices.

Key documents on the fiscal framework

Some of documents below are available in Adobe Acrobat Portable Document Format (PDF). If you do not have Adobe Acrobat installed on your computer you can download the software free of charge from the Adobe website. For alternative ways to read PDF documents and further information on website accessibility visit the HM Treasury accessibility page.

The Code for Fiscal Stability (November 1998): the Code for Fiscal Stability is designed to address past weaknesses in the fiscal policy framework. In particular, it strengthens the openness, transparency and accountability of fiscal policy. It improves the quality of information given to the public, the lack of which in the past was an important factor underlying policy mistakes.

PDF file of Fiscal Policy: Lessons from the Last Economic Cycle (November 1997)(86KB): this paper sets out the key lessons that the present Government learned from the conduct of macroeconomic policy during the preceding economic cycle and outlines the ways in which these lessons contributed to the design of the current fiscal framework.

PDF file of Delivering Economic Stability: Lessons from Macroeconomic Policy Experience (November 1998)(106KB): reviews past macroeconomic policy experience and draws lessons from this experience to inform the development of the new macroeconomic framework, which is designed to deliver economic stability. Economic stability helps businesses and people as well as Government to plan for the long term. It contributes to achieving the Government’s central objective of raising the economy’s trend rate of growth and achieving rising prosperity through creating economic and employment opportunities for all.

Reforming Britain's Economic and Financial Policy (2001): HM Treasury book, edited by Ed Balls and Gus O'Donnell, with foreword by Gordon Brown, setting out how the Government has reformed the macroeconomic policy framework in the UK.

Analysing UK Fiscal Policy (November 1999): this paper describes the objectives of fiscal policy, the institutional framework to deliver them and analyses the interpretation of the main fiscal aggregates.

Fiscal Policy: Current and Capital Spending (June 1998): this paper discusses the rationale for the Government's two fiscal rules in the light of trends in current and capital spending and their interaction with the fiscal policy framework.

PDF file of Planning Sustainable Public Spending: Lessons from Previous Policy Experience (November 2000)(82KB): the history of public expenditure control in the UK has highlighted a number of problems with the way in which governments have traditionally approached the planning and management of resources. This paper describes these previous problems and how the new system, introduced in 1997, has learnt from them.

PDF file of Fiscal Policy: A New Framework for Public Investment (December 1998)(54KB): this paper looks at the role of public investment and how it supports the government's strategy for stability and long term growth.

PDF file of Core Debt: An Approach to Monitoring the Sustainable Investment Rule (April 2002)(84KB): from Budget 2002 on, the Government will publish figures for a measure of public sector net debt excluding cyclical fluctuations. The concept is called 'Core Debt' reflecting the fact that its evolution is determined primarily by borrowing for long-term investment rather than as a result of cyclical movements in the economy. This paper sets out the details of how core debt is defined, together with an explanation of the methodology used to calculate it.

Fiscal policy analysis

End of year fiscal report (October 2007): first published alongside the 2002 Pre-Budget Report, is central to the Government's retrospective reporting and analysis of fiscal issues and builds on the information already published in the Pre-Budget Report and the Budget. This year's report looks at trends in the public finances and fiscal policy in 2005-06 and 2006-07, setting these in an historical context. The report analyses:

performance against the fiscal rules and fiscal policy objectives; and
differences between forecast and fiscal out-turn for the year-ahead forecasts published in Budget 2005 and Budget 2006.

Long-term fiscal policy

Long-term public finance report: an analysis of fiscal sustainability (December 2006): this report provides a comprehensive analysis of long-term economic and demographic developments, and their likely impact on the public finances. The Government believes sustainable public finances are a pre-requisite to achieving high and stable rates of economic growth, which in turn is essential in guaranteeing that everybody shares in the growing prosperity of the country.

PDF file of Annex A: Illustrative long-term fiscal projections (Budget 2007)(178KB): this Annex presents illustrative long-term fiscal projections providing an assessment of the long-term sustainability of the Government’s fiscal policies over the period up to 2034-35, in line with the requirements of the Code for Fiscal Stability.

PDF file of The impact of ageing on public expenditure: projections for the EU25 Member States on pensions, health care, long-term care, education and unemployment transfers (2004-2050) (February 2006)(1.6MB): this report, prepared by the Economic Policy Committee and the European Commission, presents age-related public expenditure projections for all twenty-five Member States covering pensions, health care, long-term care, education, unemployment transfers and, where possible, contributions to pensions/social security systems.

Trend growth and economic cycles

Estimation of the economy’s trend growth and cyclical position are central to the Treasury’s assessment of economic prospects and the setting of fiscal policy. ‘Evidence on the UK Economic Cycle’ presents analysis relevant to the dating of the economic cycle, informing public scrutiny and debate on the issue.

Trend growth: new evidence and prospects (December 2006)
This paper sets out the Treasury's revised view on the neutral rate of trend output growth for the post-2006 period.

PDF file of End of year fiscal report (December 2003) (350KB): Annex A of this report provides comprehensive analysis of the relationship between economic cycles and the public finances and supports the current coefficients used to calculate cyclically-adjusted fiscal aggregates.

PDF file of Fiscal Policy: Public Finances and the Cycle (March 1999)(166KB): this paper forms part of an ongoing assessment of the effects of the economic cycle on the public finances. It updates earlier Treasury analysis and takes a more detailed look at Treasury estimates of potential output and the output gap.

PDF file of Evidence on the UK Economic Cycle (July 2005)(856KB)
PDF file of Trend Growth: Recent Developments and Prospects (April 2002)(386KB)
Trend Growth: Prospects and Implications for Policy (November 1999)

European fiscal issues

PDF file of Convergence Programme for the United Kingdom (December 2006) (475KB):
Report on macro-economic policy submitted in line with the Stability and Growth Pact.

Stability and Growth Pact : a discussion paper (March 2004)

International Monetary Fund

Experimental Report on Transparency Practices: United Kingdom (March 1999) (IMF website)
Code of Good Practices on Fiscal Transparency (March 2001) (IMF website)
Manual on Fiscal Transparency (March 2001) (IMF website)
PDF file of United Kingdom 2008, Article IV Consultation (August 2008) (IMF website)

Institute for Fiscal Studies

PDF file of The IFS Green Budget (January 2007) (IFS website)

National Audit Office

PDF file of NAO Audit of Assumptions for Pre-Budget Report 2006 (NAO website)
PDF file of NAO Audit of Assumptions for Budget 2008 (NAO website)