It’s been four to five months since the Budget, and a Labour Chancellor of the Exchequer faces a conundrum. The forecasts for the economy’s performance have been too optimistic, and the borrowing figures mean that the Chancellor can no longer comply with their fiscal rules.

The Chancellor might like to either change the fiscal rules or to not comply with them, but neither option feels attainable; the Chancellor can’t even countenance it. Instead, and despite the poor economic conditions, they will feel like they have no choice – prisoner of the need to show fiscal discipline, they will tighten fiscal policy regardless of its appropriateness for the situation.

Some of the savings are arrived at by cutting departmental spending. But a substantial part of the solution they arrive at is to look at welfare payments. In particular, the Government is worried that the bill for a particular benefit has increased significantly recently, and it decides it must reform it – by which they mean restrict its generosity. This is despite the fact that there is evidence that the increase in claims comes from increased need – but the fiscal rule imperative reigns supreme.

Rachel Reeves or Philip Snowden?

Your first thought might have been that this was the predicament of current Chancellor Rachel Reeves, but all the above applied too to Ramsay MacDonald’s Chancellor Philip Snowden at the end of the Summer of 1931. Amidst the Slump (as the Great Depression was known in Britain at the time), it became clear that the iron-clad rule that Chancellor always adhered to in times of peace – that of a balanced budget – could not be met without further measures.

Unemployment had been high since the beginning of the 1920s, reaching 1.8 million in 1926, before settling at around 1.5 million by 1929. It then rose rapidly to 3 million by 1931, which represented (on a measure broadly consistent with today’s principles) an unemployment rate of around 15%.

Unemployment insurance was paid out of a fund based on workers’ contributions, and which was intended to be balanced over time. But with the Depression intensifying, it could no longer pay out claims on the basis of current levels of contributions, and the Government needed to borrow to fund it.

In August 1931, the Cabinet reconvened early in an attempt to come up with contractionary policies that would bring the budget back into projected balance. The talks failed; Foreign Secretary Arthur Henderson resigned and collapsed the administration, with MacDonald and Snowden remaining in post only through the support of the Conservatives and the Liberals as part of the National Government after they were expelled from Labour. Snowden pushed ahead with the cuts to unemployment insurance, which included both cuts to the weekly rate and increased contributions, even as the numbers in the rolls increased.

The 1931 Supplementary Budget and the broader macroeconomic policy in that Autumn are an episode which a macroeconomist can only watch through their fingers, horrified at the slowly unfolding but inevitable crash that policymakers appeared to veer into with every passing moment, unable to comprehend their role events. Snowden’s budget included both unemployment insurance cuts and broader spending cuts. It also raised income tax significantly, making the sums appear to temporarily add up.

At the same time as fiscal policy was being tightened, the Bank of England was engaged in its ultimately futile attempt to keep Britain on the long outdated gold standard parities. Interest rates were continually raised in an attempt to stave off the outflows of gold. A mere 10 days after Snowden’s statement, the UK left the gold standard never to return.

Robert Skidelsky has a damning assessment of policymaking in this period in Politicians and the Slump: The Labour Government of 1929-1931:

[The Treasury] simply controlled Government expenditure in the interests of balancing the Budget.

Effective unemployment policy demanded first of all an appropriate executive instrument with adequate research and planning facilities. The Treasury was no instrument for initiating policy, though through its control of money it was admirably placed to block it.

Some similarities are eerie

Snowden was described by Skidelsky as “completely inflexible”; an “extreme case of ministerial identification with his department’s opinions.” The Treasury’s rigid view of the need for compliance with the fiscal rule of balancing the budget trumped all else. Echoes from that time can be heard still in Rachel Reeves’ statement that her fiscal rules are “non-negotiable.”

We have long been sounding the alarm bell around the Treasury’s pathological fiscal rule derangement syndrome. This was also the message from Sir Charlie Bean – himself a former member of the Office for Budget Responsibility’s executive committee – this week: changing real policy to hit uncertain targets by minute margins is a pointless exercise, and one that we would all be better off without.

The temptation to go after welfare spending to meet these arbitrarily iron-clad rules is itself also a throwback to Snowden’s Budget. It was unemployment insurance in 1931, whose rise was claimed (without evidence) by Opposition figures such as Winston Churchill to be because of lax conditionality; disability and incapacity benefits too are rising now in a way that is seen as problematic, even as there is little evidence that any significant claims are not genuine.

These are clearly policy choices about where to put the emphasis when it comes to cutting spending – to the extent that that’s necessary. But many might reasonably ask what good a social safety net is if it can’t be relied upon when it’s most needed. The question was valid in 1931 for those unemployed, and it’s valid for those affected by the Welfare Green Paper changes now.

But there are some differences too

Snowden’s statement on 10 September 1931 cut spending by a total of £70 million. In terms of the size of the economy, this was a pretty significant change: about 1.7% of GDP. But Snowden and the Government could not make it all add up on the basis of just spending cuts, and so they too raised taxes by £82 million, or 1.9% of GDP. Rachel Reeves, on the other hand, appears set to cling on to the promise not to raise taxes again, even though that piles the pressure on just one side of the ledger.

Snowden’s predicament partly came from the rigidity of the fiscal rule that drove fiscal policy and from the little headroom he’d left himself (a mere £134,000, or 0.003% of national income). But it also came at a time of a fast-contracting economy, both in real and in nominal terms. Nominal GDP contracted by 6.5% in 1931 amid the Depression and the deflationary policy needed to attempt to remain on the gold standard. With that backdrop, meeting the fiscal rule would have always been impossible without tightening.

The same cannot be said for Rachel Reeves’ case. The Chancellor’s deliberate choice to run as close to the line as she dared in October is a large part of the story of how all the headroom evaporated. Economic news since then haven’t been brilliant, but we are far away from the conditions of the Depression. But it is reasonable to ask – given how important complying with the fiscal rules seems to be to Reeves – whether leaving such little buffer was prudent enough.

Our understanding of macroeconomics has improved a lot since 1931 – but fiscal policy practice sadly less so

Skidelsky said the Labour Government’s struggles between 1929 and 1931 were characterised by a “failure of imagination.” Politicians and civil servants were hamstrung by adherence to rules of a bygone era, and were paralysed by what they perceived as their own inability to break them. There might have been inflation and deficit spending during large scale wars, but that was seen as an emergency. They failed to see the analogy in a crisis of the scale they faced.

Even if they had seen the desirability of deficit spending, it’s doutbful the Labour Government of 1929-31 could have driven through what would have been a departure from orthodoxy. John Maynard Keynes’ General Theory of Employment, Interest and Money wasn’t published until 1936; his ideas were taking shape but were far from mainstream. MacDonald had only a minority government, and relied on the Liberals for support. He could have only dreamt of a majority, let alone one of 170.

Fiscal policy has gone in and out of fashion, and back again since Keynes’ treatise, but what has not changed is the understanding of the general undesirability of accentuating the cycle by tightening fiscal policy at times of weak or negative growth.

UK fiscal policymaking, however, appears to have regressed in the last few years into the era prior to modern macroeconomics. Incessant talk of headroom and of desperate scrambles to formally comply with fiscal rules by the skin of successive Chancellor’s teeth have exposed a system where politicians and the Treasury are again suffering from that failure of imagination that plagued interwar governments.

As Charlie Bean said at the Resolution Foundation, the adult thing to do would be to acknowledge the likely breaking of the rules and to have the confidence to wait until the Autumn. Headroom of £9.9 billion or –£5 billion are impossible to distinguish five years down the line anyway. But it’s the failure to even countenance that has landed us in the spot where policy with real consequences is being done on the fly for no good reason – and certainly no justifiable macroeconomic logic.