Trussonomics has failed at the first hurdle by John Springford
Are the UK’s institutions strong enough to stop the government’s wrong-headed fiscal policy? The markets brutally rejected Chancellor Kwasi Kwarteng’s 'fiscal event' on Friday September 23rd. As well as a large and untargeted energy bailout of households and businesses, Kwarteng announced big unfunded cuts to income tax, especially for higher earners, and reversed planned rises in payroll and corporation taxes. Markets responded by selling sterling and UK government bonds. Soon after taking office on September 6th, Kwarteng and Prime Minister Liz Truss had fired the civil servant in charge of the Treasury, Tom Scholar, as a statement of intent that the government would prioritise growth (the Treasury has a tradition of fiscal hawkishness). The government's decision not to allow the Office of Budget Responsibility to provide an independent analysis of the budget undermined investor confidence. The economic crisis the UK now faces has its roots in the Conservative Party’s decision to ignore, marginalise or even denigrate mainstream economics. Markets are now questioning whether Britain’s democratic and technocratic institutions will force the government to change course. It is unlikely that, at the time of writing, the UK is plunging into a balance of payments crisis, which occurs when foreign investors lose confidence in the ability of countries to finance their external
borrowing. Sterling fell 5 per cent against the dollar after Kwarteng’s statement, and 3 per cent against the euro. Government borrowing costs rose by 1 percentage point. It is unusual for an advanced economy’s currency to fall and government borrowing costs to rise at the same time. Usually, a fall in sterling implies a risk of recession, which prompts investors to seek safety in government bonds. But, while large, the size of these moves does not yet suggest a loss of faith in the UK’s ability to finance itself, despite a very high current account deficit (forecast to be 7 per cent of GDP in 2022). By comparison, in 1992, sterling fell 20 per cent when the UK fell out of the Exchange Rate Mechanism, the precursor to the euro. The UK’s macroeconomic framework has more safeguards against wrong-headed fiscal policy than it used to. Together, the bailout and tax cuts amount to a fiscal loosening of between 4 and 7 per cent of GDP over the next 18 months, depending on what happens to wholesale energy prices (which the government has little control over). Britain has a floating exchange rate, which means that foreign exchange markets do not have a currency peg to attack. The 1976 and 1992 sterling crises were driven by speculation that the Bank of England would not be able to raise interest rates by enough to maintain sterling’s value. The Bank is now independent of