Brian Fallow: More sports jacket than straitjacket

Act leader John Banks and Prime Minister John Key. Photo / Mark Mitchell

It is ironic that within an hour of the Treasury slashing its growth forecasts because of the mounting risk the economy will be sideswiped by another international shock, Prime Minister John Key signed a deal with the Act Party that would hobble the Government's capacity to respond to such an eventuality.

At least on paper.

But it may well be that the planned fiscal rule is more pointless than perverse. Not so much a straitjacket as a sports jacket, easily doffed.

The two parties have agreed to legislate within the next two years to impose a real per capita freeze on core Crown operating spending.

There are some carve-outs: The Crown's mounting interest bill, unemployment benefit payments and spending on natural disasters.

But beyond that spending will be limited to population growth multiplied by the rate of inflation.

This could be a source of some budgetary instability as both of those numbers swing around a lot.

The current inflation rate is high at 4.6 per cent (swollen by the Government's raising of the GST rate) while population growth has been particularly low because of the haemorrhagic loss of people across the Tasman in the past year which left us with no net gain from migration.

It seems, though, that unplanned breaches of the fiscal rule will only require the Minister of Finance to explain to Parliament why they have occurred and what the plan is to get back on track.

In that respect it may be more like the Reserve Bank's inflation target, which has been breached in 15 of the past 25 quarters.

Key acknowledges that one Parliament cannot bind the hands of its successors. That is especially true of its most fundamental prerogative, raising taxes and deciding how they are spent. Fiscal rules are not uncommon overseas.

An International Monetary Fund study in 2009 identified 23 countries with expenditure rules.

How effective they are is debatable, however.

Finland, the Netherlands and Sweden appear to have had positive experiences, the Treasury says.

But also on the list is Japan, which since 1947 has had a rule that Government expenditure should not exceed revenue.

Since 1975, except during the period between 1990 and 1993, the Government has requested a waiver of this rule every year and Japan's public debt is more than 200 per cent of GDP.

Such rules, in short, are no substitute for the political will to abide by them.