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Macroeconomic Assessment: Interest Rates, Taxes and Spending

• The UK economy has performed well in recent years. Between 1997 and 2003, the UK had the highest and most stable per capita income growth of the G-7 countries. The government claims that monetary and fiscal policy innovations played a role in this comparative success. • In the monetary area, since 1997, the Bank of England has been allowed to set interest rates in pursuit of a government-dictated target for inflation. In the fiscal area, the government introduced two rules in 1998: (i) the 'golden rule', which requires borrowing only for investment over the economic cycle; (ii) the 'sustainable investment rule', which limits net debt to 40% of national income. • The monetary policy framework has performed well by historical standards. Inflation has remained close to its target level. Inflation expectations have also converged to the target, suggesting that policy is credible. This has probably contributed to a drop in unemployment, by moderating wage demands. • Fiscal policy is more controversial. The golden rule seems likely to be met over the current cycle but it is vulnerable to claims of 'fudging' because the government maintains several degrees of freedom in assessing compliance. Nevertheless, it seems to have aided fiscal discipline compared with previous periods. • Whether the golden rule is narrowly met or narrowly missed in this cycle, or whether there is a degree of 'fudging', is largely unimportant from a macroeconomic perspective. This is because any deviation from the rule is likely to be small. In a world of uncertainty and external economic 'shocks', any government would be unwise to set policy to hit the golden rule with 100% certainty. • The Labour government's monetary and fiscal policy frameworks have contributed to the current stable economic climate. But the structural reforms introduced by the previous Conservative administration also played a positive role.