Golden Rule (fiscal policy)

The Golden Rule is a guideline for the operation of fiscal policy. The Golden Rule states that over the economic cycle, the Government will borrow only to invest and not to fund current spending. In layman's terms this means that on average over the ups and downs of an economic cycle the government should only borrow to pay for investment that benefits future generations. Day-to-day spending that benefits today's taxpayers should be paid for with today's taxes, not with leveraged investment. Therefore, over the cycle the current budget (i.e., net of investment) must balance or be brought into surplus.

The core of the 'golden rule' framework is that, as a general rule, policy should be designed to maintain a stable allocation of public sector resources over the course of the business cycle. Stability is defined in terms of the following ratios:

  1. The ratio of public sector net worth to national income
  2. The ratio of public current expenditure to national income
  3. The ratio of public sector income to national income.

If national income is growing, and net worth is positive this rule implies that, on average, there should be net surplus of income over expenditure.

The justification for the Golden Rule derives from macroeconomic theory. Other things being equal, an increase in government borrowing raises the real interest rate consequently crowding out (reducing) investment because a higher rate of return is required for investment to be profitable. Unless the government uses the borrowed funds to invest in projects with a similar rate of return to private investment, capital accumulation falls, with negative consequences upon economic growth.

The Golden Rule in the United Kingdom

The Golden Rule was one of several fiscal policy principles set out by the incoming Labour government in 1997. These were first set out by then Chancellor of the Exchequer Gordon Brown in his 1997 budget speech. Subsequently they were formalised in the Finance Act 1998 and in the Code for Fiscal Stability, approved by the House of Commons in December 1998.

In 2005 there was speculation that the Chancellor had manipulated these rules as the treasury had moved the reference frame for the start of the economic cycle to two years earlier (from 1999 to 1997). The implications of this are to allow for £18 billion - £22 billion more of borrowing.[1]

The Government's other fiscal rule is the Sustainable investment rule, which requires it to keep debt at a "prudent level". This is currently set at below 40% of GDP in each year of the current cycle.

As of 2009, the Golden rule has been abandoned.

The Golden Rule in France

In France, the lower house of parliament voted in favour of reforming articles 32, 39 and 42 of the French constitution on 12 July 2011.[2] In order to come into force the amendments need to be passed by a 3/5 majority of the combined upper and lower houses (Congress).

The Golden Rule in Germany

In 2009 articles 109, 115 and 143 of Germany's constitution were amended to introduce the Schuldenbremse ("debt brake"), a balanced budget provision.[3] The reform will come into effect in 2016 for the state and 2020 for the regions.

The Golden Rule in Spain

On 7 September 2011, the Spanish Senate approved an amendment to article 135 of the Spanish constitution introducing a cap on the structural deficit of the state (national, regional and municipal).[4] The amendment will come into force from 2020.

The Golden Rule in Italy

On 7 September 2011, the Italian Lower House approved a constitutional reform introducing a balanced budget obligation[5] to Article 81 of the Italian constitution. The rule will come into effect in 2014.

See also

References

  1. ↑ Brown postpones spending review 'to give himself a clean sheet before move to No 10' The Daily Telegraph, 23 July 2005. Retrieved 8 February 2008
  2. ↑ {fr}http://www.gouvernement.fr/gouvernement/la-regle-d-or-pour-proteger-les-francais-du-deficit
  3. ↑ Germany's Schuldenbremse
  4. ↑ http://www.france24.com/en/20110907-spain-passes-golden-rule-reform-fend-off-eurozone-sovereign-debt-crisis-parliament
  5. ↑ au.news.yahoo.com/thewest/.../italian-cabinet-agrees-budget-plan/

Further reading