The Golden Rule of Government Spending is a fiscal policy principle stating that a government should only borrow money for the purpose of investing in projects that will yield long-term benefits. It mandates that borrowing should not be used to cover current expenditure, such as salaries, welfare payments, or other ongoing costs.
Applications
European Union
In 1997, the Stability and Growth Pact (SGP) of the European Union codified this rule to ensure fiscal discipline among member states. The Maastricht Treaty laid the groundwork by stipulating that government deficit should not exceed 3% of the GDP.
United Kingdom
The UK adopted this principle under Chancellor Gordon Brown in the late 1990s. Brown’s “Golden Rule” was a cornerstone of fiscal policy, stating that over the economic cycle, the government would borrow only to invest, not to fund current spending.
US Approach
The United States does not explicitly adhere to the Golden Rule but follows a semblance of it through its budgetary policies. While the federal government has accumulated significant amounts of debt for both investment and current expenditures, certain states, such as California, have constitutional amendments requiring balanced budgets.
Balanced Budget Amendments
Some U.S. states have adopted legislation that mirrors the intent of the Golden Rule by mandating a balanced budget, constraining borrowing to select infrastructure projects.
Special Considerations
Economic Cycle
The application of the Golden Rule can be sensitive to the economic cycle. During periods of economic downturn, there may be increased pressure on governments to engage in deficit spending to stimulate growth through both investment and current spending.
Public Infrastructure
Infrastructure projects, such as highways, bridges, and public buildings, are classic examples of investments that fit well within the Golden Rule. These projects generate future economic benefits and can justify borrowing.
Examples
High-Speed Rail Systems: Governments might issue bonds to finance high-speed rail systems, expecting that the increased connectivity and efficiency will boost long-term economic growth.
Renewable Energy Projects: Investment in renewable energy infrastructure might be financed through borrowing, with the expectation of future savings and environmental benefits.
Historical Context
The idea of constraining government borrowing to investment purposes can be traced back to classical economics. John Maynard Keynes, in contrast, advocated for strategic deficit spending during economic downturns, regardless of whether the spending was current or investment-based.
Comparisons
Golden Rule vs Balanced Budget Rule
- Golden Rule: Allows for borrowing but restricts it to investment purposes.
- Balanced Budget Rule: Requires that a government’s revenues and expenditures balance over a fiscal period.
Related Terms
Fiscal Policy: Government policies regarding taxation, government spending, and borrowing.
Public Finance: The study of the role of the government in the economy, particularly in the management of public revenues and expenditures.
Debt Management: Strategies employed by a government to handle its debt to ensure it remains sustainable over time.
Frequently Asked Questions (FAQs)
Does the Golden Rule apply at all times?
No, during critical times such as wars or severe economic recessions, the rule may be relaxed to allow current spending to boost the economy.
What happens if the Golden Rule is violated?
Violating the rule can lead to unsustainable debt levels and fiscal instability. Overreliance on borrowing for current spending can crowd out investment.
Is the Golden Rule universally accepted?
No, its acceptance varies. While it is seen as a prudent fiscal strategy, some economists argue for more flexible approaches depending on economic conditions.
Summary
The Golden Rule of Government Spending is a principle designed to ensure responsible borrowing by governments, limiting debt to investments that yield long-term benefits. Its application varies across different regions, with notable adherence within the EU and adaptations in various forms in the US. By focusing on investment rather than current expenditure, the Golden Rule aims to promote sustainable fiscal policies and long-term economic health.
References
- Stability and Growth Pact, European Union
- Fiscal Policies in the UK, HM Treasury
- Balanced Budget Requirements, National Conference of State Legislatures (NCSL)
