U-turn in UK: Room for fiscal fireworks is limited

After 10 days of sustained pressure following her administration’s first “mini-budget”, UK Prime Minister Liz Truss was forced into a U-turn on a major aspect of her fiscal plans. Just hours after insisting that the plan would be executed as announced, the government — through Chancellor of the Exchequer Kwasi Kwarteng — said it would not go through with a tax cut for those earning more than £150,000. The pound, which had collapsed over the previous week to a historic low, revived slightly against the dollar as a result. The tax cut itself was more signalling than anything else, since it would amount to a giveaway of less than £3 billion a year. Yet it appeared to defy both political and economic logic. The Labour Party, which is in the Opposition and was having its national convention at the time, lapped up the economic news and presented itself as “the party of sound money”, rising thereby to a 20-point lead in many polls. Some Conservative Party MPs openly rebelled against the tax plan, putting the government’s very ability to push it through the lower house of Parliament in doubt. Although Ms Truss and Mr Kwarteng fought back against their own MPs, the media narrative, and the markets as best they were able, they eventually were forced to give in at least partially.

Ms Truss can at least claim that she is doing what she was chosen to do by the Conservative Party members as leader. In debates with her leadership rival Rishi Sunak over the summer, she made it very clear that she would cut taxes and “unleash investment” thereby. Mr Sunak warned in those debates that putting through a plan without the official costing carried out by the Office of Budget Responsibility, as Ms Truss intended, would be dangerous — and so it proved, since the “mini-budget” was not accompanied by the usual clear fiscal mathematics and therefore the markets were spooked even more than they would have otherwise. The International Monetary Fund (IMF) said the fiscal package was “untargeted” and contradicted the Bank of England’s efforts to tamp down on inflation. The IMF’s statement was unprecedented in its tone when it comes to its observations on policy framed in a developed economy. Even the US commerce secretary argued that “businesspeople want to see world leaders taking inflation very seriously, and it’s hard to see that” in the Truss government.

Ms Truss is not the only world leader who wishes to prioritise growth over inflation control at the risk of roiling the markets. Turkey’s Recep Erdogan has been attempting this for some time, with the consequence that growth is high but inflation is at a 24-year high of 83.45 per cent. The Bank of England is still independent, so it is hard to imagine similar consequences. But the swift reaction in the bond and foreign exchange markets makes it clear that the room even in developed economies for novel fiscal strategies is now severely limited. It is best to stick to tried and tested methods of reviving growth — deregulation, macroeconomic stability, and targeted investment. There is enough low-hanging fruit in any economy, including the UK’s, for growth and productivity to be revived post-pandemic without any more fiscal fireworks than those that have already been announced in the past.