Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Balanced budget rule

A balanced budget rule simply says that, over a period of time, the

amount of government spending should be exactly equal to the amount raised in taxes.

Every year the government has to decide how much money to spend. At the same time, it has to fund this expenditure somehow. The standard way of doing so is by raising tax revenue, be it from income tax, VAT, corporation tax and so on. Of course, the rule needs to specify the time period over which it must be met, perhaps yearly, or over the course of a Parliament or the course of a business cycle (a period of time that includes a boom and a recession). This final period is a bit tricky, because economists don’t have an agreed way to measure the start and end of a business cycle.

The rule has some flexibility built in. That is, sometimes the government can run a deficit (it spends more than it receives in taxes) so long as it runs sufficient surpluses to balance the budget over the chosen period of time. Despite this, balanced budget rules aren’t in widespread use (for reasons we discuss in Chapter 11). In the US, a number of state governments (but not the Federal government) follow a balanced budget rule.

Keep an eye out, though. In June 2015 UK Chancellor George Osborne announced his intention to pass a law requiring future governments to run a budget surplus so long as the economy is growing, which is essentially a balanced budget rule.

Inflation target

You may have heard this policy rule mentioned in the news. In the UK, the Bank of England (BoE) is responsible for monetary policy. In normal times this mainly involves setting the interest rate; in more recent times it has also involved deciding how much quantitative easing (QE) to carry out. (Check out Chapter 10 for all your monetary policy and quantitative easing needs.)

The BoE can’t decide on its policy willy-nilly, though. The government gives it an explicit inflation target, which it’s expected to attempt to achieve. In 2014, for example, the inflation target was 2 per cent annual inflation according to the consumer price index (CPI) measure. Although it has some discretion about how it achieves this target, the focus of monetary policy must be the inflation target and not any other measure of economic

performance. In this sense you can see inflation targeting as a form of policy rule.