Trussonomics: a lesson in credibility
Updated: Nov 19, 2022
After just 44 days of economic and political upheaval, Liz Truss announced her resignation as the PM of the country. By the end of the month, the UK would have had 3 Prime Ministers in just 8 weeks, 2 of whom did not have to face a general election to reach office. Further, Jeremy Hunt (the new Chancellor of the Exchequer) is expected to announce new fiscal policy plans after essentially scrapping the disastrous ‘mini-budget’. Expected to take place on the 31st of October, this might be derailed by the new Prime Minister’s possible reselection of the Cabinet.
Politically speaking, the Conservative Party has lost wide swathes of public support and the last 6 weeks have forever tainted their reputation of a good economic record. With Labour peaking at more than 30 points ahead, there was a point where predictions suggested the SNP could have become the official opposition party if there were a general election held now.
However, arguably, the biggest lesson to come out of this debacle is the ideal of confidence and credibility. Truss, in the Conservative party leadership races, commented on the ‘orthodoxy’ of the Treasury and –through her policies – showed disregard for the Bank of England, the independent Office of Budget Responsibility, and the civil service.
The government labelling the mini budget as a fiscal event was most likely their flawed reasoning to block an official Office of Budget Responsibility report that would have been extremely useful for the Monetary Policy Committee to use as an official forecasting tool ahead of the 3rd of November decision regarding the interest rate. Truss’ pre-emptive firing of Tom Scholar – the Treasury’s permanent secretary – was also likely a plan to control dissent within the party. Without reliable forecasts from the OBR, their policies are essentially a blind leap of faith, which the public do not share. In a time of economic turmoil and the prospect of thousands facing absolute hardships, the least we can expect from the government is transparency and integrity.
Most significantly, the reeling markets forced the Bank of England to act against their earlier plans for a ‘quantitative tightening’ when they had to bail out the gilt markets for £65 billion. For a few days, tensions were extremely high when it was unclear if Andrew Bailey was serious about the emergency buy-ins ending strictly on the 14th of October. If the markets had not yet adjusted and the central bank were pressured into going back on their word, it would have caused irreparable damage to its credibility.
Ironically, it's these institutions that Truss tried to undermine that have stood strengthened and had a significant role in her resignation. Slightly reminiscent of Johnson’s departure, the loss of power recently has been coupled with problems of foregoing institutional checks and balances and not accepting accountability in the face of grave mistakes. Proposing unpopular policies and promising to follow through until public pressure reaches a boiling point to then announce another U-turn has been the modus operandi for much of the past 2 years. Poor governance has meant that the UK has an extremely tough road ahead in convincing investors of its potential. However, and more troubling, is the effect this has had on regular people. With the prospect of another period of austerity looming, and this winter set to be particularly tough due to the cost-of-living crisis, it is unlikely we will see the economy recover for the foreseeable future.
This horrible episode in British history has delivered an effective blow to the rising anti-institutional rhetoric that has been on the rise for recent years. The importance of the Bank of England and the OBR, especially, has taken centre-stage and might make international investors more comfortable. There does, however, lie a huge caveat about who is elected as the next Prime Minister. If Johnson were to return, it would be farcical and would lead to important questions about the health of democracy in the UK and is extremely unlikely to boost confidence. Sunak would be more likely to prioritise stability and might not delay the 31st of October fiscal plans by Hunt, which might prove crucial.
The cost of restoring market credibility is likely to be in the form of spending cuts. Another round of austerity would add pressure to already buckling sectors of the NHS, the care industry, and other public services. It is also unclear if the plans to help people with rising energy costs will continue and the degree of assistance it would offer. Further, the chaos caused by poor fiscal management might lead to an overly cautious fiscal restraint that is likely to plague the direction of economic policy, at least until the next general election.
The resignation of Truss has also led to predictions that the Bank of England might raise interest rates by less than previously thought on their 3rd of November MPC meeting. ING’s analysis suggests that “The Bank essentially faces a choice between hiking aggressively and baking in the ultra-high level of mortgage and corporate borrowing rates, amplifying the depth of a recession through the first half of next year – or undershooting market expectations, at risk of a weaker pound and more imported inflation.”
In the longer term, ING economists put the ‘political risk premium’ at around 0.5% in 10-year borrowing costs in comparison to the USA and Germany, possibly affecting millions of households and businesses. They also commented that it takes years to build confidence, and only one day to destroy it.
Overall, economic institutions that have provided checks and balances to the government have come out of this with a bolstered reputation, in stark contrast to the Conservative party. The next few weeks will be crucial in seeing if the markets remain fairly stable with the new premiership and the next government will have a tough road ahead trying to restore its battered credibility.