Q&A: Government's fiscal rules

The Treasury may announce a changes to the government's fiscal rules

The government is considering rewriting its own rules on how much it can borrow in order to counter the effects of the economic slowdown.

The new framework, which could be announced in the autumn pre-Budget statement, would permit more borrowing as an alternative to increasing taxes.

The current rules were laid down by Gordon Brown during his time as chancellor after Labour came to power in 1997.

What are the government's fiscal rules?

The government has two rules on spending and debt. The Treasury's "golden rule" states that over the course of the economic cycle, it can only borrow to invest.

This is meant to stop discretionary spending and tax cuts that result in mere short-term boosts to the economy.

Public sector net debt should also be no more than 40% of national income. This is known as the sustainable investment rule.

Are these rules in danger of being breached?

Public sector net debt stood at 38.3% in June.

After falling in Labour's first term, public sector net debt has been rising each year since 2001 as government spending on education, health and other areas has increased.

The economy is expected to slow sharply in 2008 and 2009 and this means the government will receive less revenue from income tax, VAT and stamp duty.

This makes it more likely that the government will have to borrow to fulfil its existing spending commitments.

Furthermore, if you include Northern Rock, now in public hands, net debt already stands at 44.2% of national income, according to the Centre for Economics and Business Research.

Why does the Treasury want to change the rules?

Breaking these rules would allow the government to provide a much-needed boost to the slowing economy and avoid the need to raise taxes.

However, it would also damage the government's reputation for economic management.

Instead, Chancellor Alistair Darling may take the opportunity to declare the current economic cycle over and the two rules passed, following a revision to the national accounts expected in September.

By changing the way the UK financial sector is valued, the Official for National Statistics is expected to increase the estimated size of the economy, giving the government more room to meet the 40% debt ceiling in this financial year.

The government could then press ahead with reforms to the rules, giving itself more room to borrow its way out of the most difficult economic period since the recession of the early 1990s.

However, such a move would still be criticised by opposition parties and undermine Gordon Brown's reputation for economic prudence.

What is an economic cycle?

The Treasury says a full economic cycle includes both a period in which output is above potential and a period in which it is below potential.

However, it is a concept that is open to interpretation.

The current economic cycle, which began in 1997/98 financial year, may have ended in the 2006/7 financial year, although this was never formalised.

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