I’m giving Labour’s new “fiscal rule” seven out of ten.

It’s certainly better than the lies and nonsense we got from George Osborne when he was UK finance minister.

The rule is that government income must equal government spending over a five year period, but with two exceptions. The first is that government can borrow to make investments, and second, spending can exceed income by even more when interest rates decline to zero (because in that circumstance the only alternative way of boosting the economy is to cut interest rates to below zero and there are well known problems there).

The main problem with the new fiscal rule has to do with investment. The idea that investment justifies borrowing may sound sensible, but in fact no household or firm abides by that rule. Reason is that the idea is nonsense: e.g. if a taxi driver wants a new taxi and happens to have enough cash to pay for it, perhaps because he’s been saving up,  he won’t borrow: he’ll just pay cash. Quite right. I.e. what justifies borrowing is a shortage of cash. But governments are never short of cash in that they can grab limitless amounts of cash from taxpayers (and print a limited amount of money every year).

Plus education is one huge investment (in the future of our children), but no one ever suggests funding the entire education budget via borrowing. Thus the whole “investment justifies borrowing” idea is nonsense, or at least advocates of the idea have a lot of work to do before they’ve got their house in order.

In fact if the latter questionable idea about borrowing for investment was removed from Labour’s fiscal rule, then the rule would amount to something very similar to the permanent zero interest rate idea advocated by Milton Friedman and Warren Mosler. Reasons are as follows.

A balanced budget is bound to have a deflationary effect (that’s deflation in the “demand reducing” sense). Reason is that if the stock of base money and government debt is not constantly topped up via a deficit, then the real value of that stock will decline relative to GDP because inflation constantly eats away at the value of that stock. And when the private sector has what it thinks is an inadequate stock of base money and government debt, it will tend to try to save so as to acquire its desired stock. The effect of saving is deflationary.

Thus under Labour’s fiscal rule minus the “borrow for investment” element, interest rates will tend to bump along just above zero and actually hit zero from time to time. Clearly that is similar to the above mentioned permanent zero interest rate scenario.

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