Golden Rule (fiscal policy)
Encyclopedia
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 (ie, 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:
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
.
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.
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.
on the 12 of July 2011. 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).
's constitution were amended to introduce the Schuldenbremse ("debt brake"), a balanced budget provision.. The reform will come into effect in 2016 for the state and 2020 for the regions.
Fiscal policy
In economics and political science, fiscal policy is the use of government expenditure and revenue collection to influence the economy....
. The Golden Rule states that over the economic cycle, the Government will borrow only to invest
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
and not to fund current spending
Current account
In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...
. 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 (ie, 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:
- The ratio of public sector net worth to national income
- The ratio of public current expenditure to national income
- 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
Macroeconomics
Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy...
. Other things being equal, an increase in government borrowing raises the real interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
consequently crowding out
Crowding out (economics)
In economics, crowding out occurs when Expansionary Fiscal Policy causes interest rates to rise, thereby reducing private spending. That means increase in government spending crowds out investment spending....
(reducing) investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
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
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
falls, with negative consequences upon economic growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...
.
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.
The Government's other fiscal rule is the Sustainable investment rule
Sustainable Investment Rule
The sustainable investment rule, as referred to in the United Kingdom, is 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...
, 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.
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 constitutionConstitution of France
The current Constitution of France was adopted on 4 October 1958. It is typically called the Constitution of the Fifth Republic, and replaced that of the Fourth Republic dating from 1946. Charles de Gaulle was the main driving force in introducing the new constitution and inaugurating the Fifth...
on the 12 of July 2011. 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 GermanyGermany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
's constitution were amended to introduce the Schuldenbremse ("debt brake"), a balanced budget provision.. The reform will come into effect in 2016 for the state and 2020 for the regions.
The Golden Rule in Spain
On the 7th of 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). The amendment will come into force from 2020.The Golden Rule in Italy
On the 7th of September 2011 the italian lower house approved a constitutional reform introducing a balanced budget obligation to article 81 of the italian constitution. The rule will come into effect in 2014.Further reading
- Fiscal Policy in the UK (HM Treasury)
- HM Treasury. Reforming Britain's economic and financial policy: towards greater economic stability. Basingstoke: Palgrave, 2001. ISBN 0-333-96611-2.