There is much to say about 2025, and there may be more next week, but one definite feature of the year is that the conduct of fiscal policy has been so unsatisfactory. I’ll go further: it has been pretty disastrous. An air of crisis has surrounded the public finances for most of the year. The long build-up to last month’s budget was damaging and destabilising.
The year is ending on better note, with the market for gilts (UK government bonds) being reassured by the chancellor’s decision to give herself more fiscal headroom in her budget, and by a sharp drop in inflation last month, from 3.6 to 3.2 per cent.
This cemented Thursday’s interest rate cut by the Bank of England’s monetary policy committee from 4 to 3.75 per cent. The vote, 5-4, was as close as I suggested a week ago, though data ahead of the MPC meeting might have led to a clearer cut. Certainly, a faltering economy, rising unemployment and a sharp fall in inflation were a solid rate-cutting combination.
There is, however, a fragile truce between the government and the markets, and the UK is no model for others to follow. Fiscal policy should be straightforward, as practised by chancellors for centuries. Governments decide what they want to spend, or what they cannot avoid spending, and raise the taxes necessary to pay for it.
Within that, governments can run a budget deficit or surplus, depending on conditions and where the country is in the economic cycle. Deficits are normal, indeed necessary and perfectly healthy, in recessions. Surpluses can be expected when the economy is booming, tax revenues are flooding in and unemployment falling.
That was how it used to be. These days, budget surpluses are as rare as hen’s teeth: there have only been ten in the past 70 years and none in the past 25. This government is not aiming for an overall surplus. In the unlikely event that everything pans out as predicted by the Office for Budget Responsibility (OBR), public sector net borrowing — the budget deficit — at the end of this parliament, 2029-30, will be £68 billion — just under 2 per cent of gross domestic product (GDP).
That would meet one of the government’s fiscal rules — of only borrowing to invest, or achieving a current budget balance or better — because public sector net investment is planned to be just under £90 billion, or 2.5 per cent of GDP. Current budget balance means revenues match day-to-day spending.
Governments make fiscal rules, and the two that Rachel Reeves has adopted — current budget balance or better, and debt on her chosen measure falling as a percentage of GDP in five years — are as good as any adopted by recent chancellors.
The question is whether they are good enough. As the OBR put it last month: “Even if the government were to meet its fiscal rules and reduce overall borrowing to below the roughly 2.5 per cent of GDP it invests by the end of the decade, this would reduce the UK’s deficit only to the level that the average advanced economy had already achieved several years ago.
“And it would only just be enough to leave the UK’s debt, which has nearly tripled since the start of the century, stabilising at 96 per cent of GDP by the end of the decade. That would leave the UK with a debt-to-GDP ratio around twice the advanced-economy average and the sixth-highest among advanced economies.
“And the UK would still be devoting more of national income to paying interest on debt than at almost any time in post-war history.”
That is a serious problem, and not the only one. In a new paper, “Rethinking the UK fiscal framework: lessons from elsewhere”, by Professor Iain Begg of the London School of Economics, published online by Cambridge University Press, the sheer strangeness of how the UK does fiscal policy shines through.
Twice this year, we have seen the chancellor explicitly changing policy to meet a target in five years’ time. In March, Reeves unveiled politically problematic cuts in disability benefits, which were soon reversed, and last month taxes were raised to provide more headroom in meeting those fiscal rules.
• Fiscal ‘headroom’ obsession creates budget tax migraine
Not only is this well-nigh impossible to explain to voters, but, as Begg points out, it does not fare well on any sensible assessment of what is needed to control debt and deficits.
“It relies on a double estimation, namely of the expected trends in both government revenue and spending, and on the trajectory of the economy,” he writes. “It is, as so many critics have argued, surprisingly loose insofar as the deadline always in the future does not preclude slippage in the short term.”
This was exactly what we saw with last month’s budget. But as well as that, the rules themselves are subject to change, as they have been eight times since 2011.
Other countries do it better. Denmark, Sweden and Finland have expenditure ceilings, which governments are expected to live within, and lower debt relative to GDP than the UK — much lower in the case of Denmark. Spain, Austria and even Italy have used expenditure rules to better control public spending, which is more effective in getting a grip on debt.
This makes sense. Governments can control public spending, or should be able to do so, while they are unable to control the wider economic circumstances that affect tax revenues, and thus deficits and debt.
There are other models that could be adopted, many of which work better. The UK is not bottom of the class, says Begg, but “the evidence from countries that have much better fiscal indicators is, or should be, persuasive in stimulating a new approach”.
This could be a good time to do it. The budget has left the chancellor with some breathing space, and another is not due until next autumn. The government is in the process of appointing a new chairman of the OBR, so why not at the same time adjust the fiscal framework? If not, this year’s highly unsatisfactory approach to fiscal policy will be the shape of things to come.
PS
It is the moment you have been waiting for: my Christmas quiz. There will be prizes, including a possible school or college visit if students are successful. You have plenty of time: answers please by close of play on Sunday, January 4, two weeks’ time. I can also report a flood of jokes after last week’s request, but do not stop now. There will be a smattering at the end of today’s quiz, and more over the next couple of weeks. Anyway, on with the quiz.
1. How many times did the Bank of England cut interest rates in 2025?
2. Which former Bank of England chief economist described the build-up to last month’s budget as a “circus”?
3. What did the Office for Budget Responsibility (OBR) revise down by 0.3 per cent a year, causing a headache for the Treasury?
4. What was the name of the OBR chairman who resigned over an inadvertent budget leak?
5. Donald Trump introduced new tariffs on imports from most countries. What is the “baseline” tariff on imports from the UK? (a) Zero (b) 10 per cent (c) 20 per cent?
6. As of today, Rachel Reeves has been chancellor for 534 days. Where does that place her, in time in office, among the six chancellors since 2019, beginning with Sir Sajid Javid?
7. The national living wage — the minimum wage — will rise to £12.71 an hour in April. By then, by how much will it have risen over ten years? (a) 37 per cent (b) 57 per cent (c) 77 per cent?
8. An American economist famous for his curve visited Britain and offered unsolicited advice to Rachel Reeves. What is his name?
9. The body responsible for monitoring and policing global trade celebrated its 30th anniversary this year. What is it?
10. UK taxes as a percentage of gross domestic product — the tax burden — are estimated by the OBR to be 36.3 per cent this year, on their way to a record. By how much has the burden risen since 2019-20, before the impact of Covid? (a) 2 per cent of GDP (b) 3.4 per cent (c) 4.8 per cent?
After all that, we need a couple of jokes. From an excellent selection sent in by Baroness (Ros) Altmann: “I told my female colleague that she drew her eyebrows too high. She seemed surprised.” And: “What did the ruthless boss say to their workers? If at first you don’t succeed, you’re fired.”
Finally, for this week, Paul Hambrook doesn’t claim it as his own, but I liked it: “If you’re stuck for a Christmas gift for your partner and you don’t want them to be disappointed — buy them a fridge and watch their face light up when they open it!” More to come, I’m afraid.
david.smith@sunday-times.co.uk