Why do governments tie their own hands with fiscal rules?

Governments tie their own hands with fiscal rules because politicians are tempted to spend now and send the bill to the future. Economists call this deficit bias, a tendency of governments to allow increasing long-term deficits. A rule, such as a limit on borrowing, is a promise made in advance that is meant to be harder to break when the pressure comes.

Rules come in many shapes. The UK's Golden Rule says that over the economic cycle the government should borrow only to invest, not to fund current spending. Behind it lies an argument that extra government borrowing raises real interest rates and crowds out investment. Germany's debt brake, enacted in 2009, restricts annual structural deficits to 0.35 percent of GDP. The EU's Stability and Growth Pact asks member states to stay within limits of 3 percent of GDP for deficits and 60 percent for debt.

Rules also create a game of finding loopholes. The line between current spending and investment can encourage creative accounting. In 2005 there was speculation that the UK Chancellor had manipulated the Golden Rule by moving the start of the economic cycle two years earlier, which allowed 18 to 22 billion pounds more borrowing. In March 2005 the EU Council, under pressure from France and Germany, relaxed the Pact's rules.

To make rules credible, many countries have set up fiscal watchdogs. After the 2008 crisis, several fiscal councils were created. The UK's Office for Budget Responsibility provides independent forecasts and assesses whether the government is likely to meet its targets. Not everyone thinks rules are wise: economists disagree about Germany's debt brake, and this lesson takes no side.