Liz Truss, who became British Prime Minister less than a month ago, may have set a political speed record. She’s certainly not the first leader to be forced to adopt a no-show policy in the face of adverse market reactions. But announcing an economic program and then abandoning its central plan just 10 days later is something special.
And those of us in the center left can, I think, be forgiven for feeling a little bit frustrated. Conservatives repeatedly warn that progressive policies will be punished by “bond alert“, they claim to push up interest rates with the prospect of public spending rising. Such warnings are often proven false. In the UK, however, bond-warns have indeed emerged; interest rate jump up after the Truss government announced its economic plans. But the market is not reacting to overspending, it is reacting to tax cuts irresponsibly.
That said, the story is simple – Truss proposes policies that could increase the budget deficit and cause inflation, and the markets react by pushing interest rates up and the pound falling – miss out. much of what actually happens. This is both a matter of more and less than dollars and cents (or, I guess, pounds and pence). Instead, it is primarily about a government squandering its intellectual and moral credibility.
How big of tax cuts did Truss propose? She and her officials announced their policy without a budget point, which contributed to a loss of market confidence. However, there are independent estimates; e.g. Resolution Foundation, a British think tank, estimates Truss tax cut at £146 billion over the next five years, about 1% of the GDP forecast in the same time period. It’s not trivial, but it’s not great either. And the specific tax cut just dropped, the top tax rate cut, is just a fraction of that total.
So why is the market reaction so harsh? In part because Truss and Kwasi Kwarteng, the leaders of the Exchequer, justified their moves with lost a lot of reputation claims that the reduction of the highest tax rates will create a huge engine for economic growth. This raises doubts about their competence and indeed their connection to reality; it is never good when economists at big banks declare that a country’s ruling party has become a “doomsday cult. “
Questions about Truss’ judgment are bolstered by the ambiguity of her timing. Right now, ordinary Europeans, including the British, are facing tough times, largely as an indirect consequence of Russia’s invasion of Ukraine. The Ukrainians, amazingly, seem to be winning the war; That does not detract from their courage to say that Western weapons have played an important role in their success. So Vladimir Putin tried to put pressure on the West by cutting off natural gas flows.
This is a huge one adverse economic shock to Europe, perhaps larger than the oil shock of the 1970s. Governments are trying to limit the pain of soaring energy bills. But all of Europe – again, including Britain – is facing something like economic war. (America is much less affected, although natural gas prices here have also increased.) And as in wartime, government policies need to promote a sense that everyone is in it together. .
At the time, tax cuts for the rich, who are already less affected by higher energy prices than those on lower incomes, would instead send the message that only Only small children face difficulties. The message is particularly virulent because the British public has been abuzz about cuts to public services, particularly health care, and want to see Taxes increase, not decrease, to pay more. And it’s hard to run efficiently when you’ve angered most of your country.
There was another factor in the market turmoil created by Truss’ proposals, which amplified the effect of discredit. It turned out that the British pension funds, which owned a lot of British government bonds, tried to mitigate the risk by complex financial strategy that requires them to put in more cash as interest rates rise and bond prices fall. When interest rates suddenly spike, pension funds can’t raise enough cash in the short term – and this threatens to force a bond sale that will push rates higher. The Bank of England’s emergency intervention limited the damage, but the situation added to the anxiety.
And yes, with interest rates rising almost everywhere, one has to wonder if there are other financial crises waiting to happen. The bond crisis in the UK is perhaps unique, but no one who remembers 2008 can avoid feeling anxious.
But back to the downfall of Truss. As I said, the market backlash to the new prime minister’s plans isn’t just about money. In difficult times, leaders need to be seen as both real and fair. What Britain has instead is a leader who seems to live in an imaginary world and has no regard for social solidarity. And it will be difficult to make up for the damage she caused in just a few days.
