What is Golden Rule in Fiscal Policy?

May 14, 2015

The Golden Rule of fiscal policy is a bugetary or fiscal policy guideline which says that the government should use the borrowed fund (debt) in such projects that benefits the future gnerations who have the responsibility for repaying the debt.

“The golden rule stipulates that over the economic cycle, the government should borrow only to invest and not to fund current spending.” The Golden Rule hence advocates intergenerational equity while formulating fiscal polity. It is applicable especially for those governments which resorts to high level of debt or borrowing to finance thier budget. The implicit message of the golden rule is that it is not desirable to use debt to finance expenditure like running of government machinery (revenue expenditure), payment of pension, salary etc. which overwhelmingly benefit the current generation.

The Golden Rule of Fiscal Policy states that over the economic cycle, the Government should borrow only to invest and not to fund current spending (current expenditure means day to day running expenses). In layman’s terms, this means that the government should borrow to finance investment that benefits future generations.

Figure: Borrowing trends of the central Government.

Historically, in India, we are haging high revenue deficit for the central government and for most of the states. The revenue deficit is financed out of capital budget surplus. This capital budget surplus is brought by huge borrowing. If capital budget surplus is borrowing, revenue deficit is due to high subsidies, interest payments etc. All such payments are benefiting the present generation. But the burden of debt payment goes to the future generation. To correct this, the government should use the borrowed money in projects that benefit the future generation also.

Basic principle of the golden rule is that while practicing the budget, the government should follow intergenerational equity. If the government uses the borrowed fund to finance current expenditure or the expenditure to pay pension and salaries, the benefit will go to the present generation. On the other hand, the people who have to repay the debt is the future generation. Hence, the repaying group or the future generation should also get the benefit of government borrowing and spending. Here, the best way is to spend the borrowed money of projects like infrastructure which benefits the future generation.

The policy suggestion of golden rule is that government’s budget should have no revenue deficit. Revenue deficit is a situation where the government’s day to day earnings from tax and non tax revenues are not enough to finance is day to day activities.

Increasing share of capital expenditure is a welcome development

Since the 2022 budget, the share of capital expenditure is going up. The share of capital expenditure was just 12% in 2020-21 and it went up to 22% in 2023-24 (BE). Such an increased allocation shows that the government is moving in accordance with the message of the Golden Rule.