OECD boosts Rachel Reeves with call to rewrite ‘short-termist’ fiscal rules

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The UK should rewrite “short-termist” fiscal rules to allow higher public investment that would drive growth, the OECD’s chief economist has said, in a boost to UK chancellor Rachel Reeves ahead of next month’s Budget.

Alvaro Pereira said on Wednesday that the UK’s fiscal rules, while intended to keep government debt in check, could be counter-productive.

The British rules are based on a rolling five-year horizon, which Pereira said gives ministers an incentive to delay cuts in day-to-day spending but makes it hard to justify long-term investments.

“The UK’s existing rules may tend to short-termism and the potential deterioration of the public finances in the long run,” he told the Financial Times.

“Part of the problem identified in the UK is the need to improve infrastructure and improve productivity,” he added.

The warning from the OECD, a think-tank for 38 rich economies, could help Reeves make the case for a rethink of the country’s fiscal framework — which she has indicated she is already considering — when she presents next month’s Budget.

The Labour government has put voters on notice to expect “difficult choices” such as tax rises to address what it characterises as a £22bn black hole in the public accounts left by the Conservatives.

The chancellor has adopted a fiscal rule that requires day-to-day spending to be balanced by tax receipts, allowing borrowing for investment.

But she has also said she will impose a second, tougher rule that requires debt to fall as a share of GDP between the fourth and fifth year of the official forecast.

Reeves hinted this week that she might amend her fiscal rules to accommodate new capital spending, telling the Labour party conference that the Budget would herald “an end to the low investment that feeds decline”. She added it was time for the Treasury to start counting the benefits of investment, not just the costs.

The OECD argued, in a survey of the UK economy published this month, that setting targets on the rolling five-year timeframe leads to “suboptimal fiscal policy”.

It added that, by design, “the actual date for meeting a rolling target never arrives . . . which at each point in time creates strong incentives to implement looser fiscal policy in the near years and postpone consolidation”.

The OECD report said the UK should consider shortening the time horizon of the fiscal rules, while setting clear conditions for when they could be suspended to deal with economic shocks.

It also suggested the Treasury could look at measures such as public sector net worth — which take account of “what the government owns as well as what it owes” — to help it reach a broader view of debt sustainability.

Pereira’s comments came as the Paris-based OECD published new forecasts for growth and inflation in major economies, which showed the UK among the stronger performers.

Pereira said the UK economy was already growing faster than the OECD had expected when it last published forecasts in May, with GDP now projected to expand by 1.2 per cent in 2024 and 1 per cent in 2025.

However, inflation is likely to prove stickier in the UK than in any other G7 economy on the OECD’s projections, averaging 2.7 per cent in 2024 and 2.4 per cent in 2025.

The OECD said global GDP growth had remained resilient and was set to stabilise at 3.2 per cent in 2024 and 2025, albeit with a stark transatlantic divide, with the US economy outpacing a sluggish eurozone.