All week, I had this song stuck in my head. It is a song by the East London Oi! band ‘The 4-Skins’ and the chorus is ‘chaos, chaos, chaos, don’t give a toss.’ It seems like the perfect theme song for this week in British politics! I would describe it as ‘extraordinary,’ were it not for the fact that such extraordinarily chaotic weeks have become the rule rather than the exception since 2016.
The week started with us having a Chancellor Kwasi Kwarteng, a plan not to rise corporation tax, and a plan to cap energy bills without resorting to a windfall tax on energy company profits. It ended with us having none of these things.
Another string of spectacular U-turns by PM Truss meant that her bold and radical economic policy is in tatters, and she now exclusively focuses on saving her job. By Friday, the only way to do that seemed to be to throw her closest alley and Britannia Unchained co-author Kwasi Kwarteng under the bus. In an attempt to reassure the markets, she instead appointed former Health Secretary Jeremy Hunt as the new Chancellor. Hunt is expected to adopt much more orthodox economic and fiscal policies than Kwarteng, Truss, and their libertarian backers would have liked.
I will freely admit that part of me is full of schadenfreude about the mess the Tory party is in and the fact that their libertarian policies have failed the tests of markets so spectacularly (and I’m clearly not alone, as this tweet by Ed Miliband illustrates). The problem, of course, is that the economic fall-out of the Tory-induced chaos will not hurt Tory politicians or Tory party members most, but rather it will inflict years of economic pain on the rest of us. Worse still, what we have witnessed this week was not a fight between ‘good’ and ‘bad’ (economic policies) in which ‘good’ prevailed in the end. It was a fight between two bad economic philosophies and bad prevailed over worse. Nothing illustrates that better than the clash between the government and the Governor of the Bank of England (BoE) Andrew Bailey.
The bad, the worse, and the ugly: HMG v. BoE
His Majesty’s Government (HMG) is not the only venerable UK institution that seems completely out of its depth in the self-inflicted economic chaos that has descended on Britain. In the shadow of the high-profile chaos taking place in Downing Street, the governor of the BoE too made a mess of stabilising the financial markets. On Tuesday, Andrew Bailey announced that – contrary to the wishes and expectations of the pension fund industry – the BoE’s bond-buying programme would not be extended beyond Friday 14th of October and Pension Funds therefore had three days to sort out their positions.
As a result, the whole week became a rollercoaster for the BoE and the pension fund industry. After announcing the end of the bond buying scheme, Bailey tried to calm the markets announcing a short-term borrowing facility for banks to support pension funds that require more cash once the BoE bond purchasing programme ends. The Bank also increased the daily limits on its sovereign bond purchases from £5bn to £10bn to be able to double down on its attempt to stop gilts yields from increasing further. Yet, neither of these measures worked and gilts prices continued to plummet and yields continued to rise. Partly, perhaps because the BoE – despite rising the daily limit for government bond purchases to £10bn ‘only’ bought £853m on Monday, suggesting to the markets that the BoE was not serious about its intention to stabilise prices and yields.
Pension investors, in turn, reacted to the three-day deadline – which reportedly they did not expect – by selling off more bonds still, leading to the BoE buying more of them in one day on Monday and Tuesday than in the first nine days of the programme. This may have been the intended outcome of Bailey’s announcement, but the upshot is that rather than stabilising markets the BoE’s approach to quantitative easing generated more volatility.
The London Stock Exchange resorted to the highly unusual step of allowing market makers to quote a wider-than-usual spread in prices on gilts until further notice. This step followed other highly unusual steps by the BoE intervening in the bond market twice in two days (on Monday and Tuesday) to buy up literally all bonds and to buy even inflation-linked gilts, i.e. government bonds that are linked to inflation, which showed very unusual drop in prices not justified by inflation expectations and not common for developed economies.
While some conservative commentators defend the Governor suggesting this was not a gaffe, but rather the only reasonable thing to say given the circumstances, others ask whether it is time to sack Bailey over the mixed messages he sent to pension funds about a possible extension in public and in private.
This was a textbook example of a phenomenon that critiques of central bank independence have been criticising for years. Namely, that unelected technocrats at the central bank impose their economic policy preferences on an elected government. Indeed, people like Prof. Richard Murphy of Sheffield University were very critical of the governor’s actions. Not only because Bailey did not follow internal procedures by reportedly not consulting the monetary policy committee, but also his policy of increasing interest rates to target inflation is seen as a conscious choice to sacrifice the interests of workers to satisfy the interests of financial markets.
Indeed, already in February Bailey asked workers to moderate their wage demands, despite declining real incomes, so as not to further spur inflation. That is a shoddy argument. The risk of a wage-price spiral – where increasing inflation drives up wage demands, which then contribute to higher inflation – is real. However, in the current situation inflation is very largely caused by supply shocks resulting from the Covid19 pandemic and the impact of Russia’s war on Ukraine on energy prices. Therefore, most likely, wage restraint will not do much to rein in inflation. Rather, decreasing real wages will lead to decrease domestic demand, thus increasing the risk of a recession.
For the BoE, the latter does not seem to be a particularly worrying prospect. To the contrary, central bankers not just in the UK, but around the world have recently argued that a recession is needed to bring down inflation. That again, is a conscious choice to sacrifice working people’s and homeowners interests in the name of the fight against inflation, which mainly benefits employers and investors. Indeed, the Financial Times’ Martin Sandbu argued last week that central banks around the world are trying to ‘ease’ the pressures ‘tight’ labour markets put on employers by artificially inducing a recession through interest rate increases. Not only will this lead to increased unemployment and less disposable income for both wage earners and homeowners, but also will it reduce incentives for firms to use labour more productively in face of shortages in labour supply. Lack of productivity increases are of course one of the UK’s main economic problems at least since the Global Financial Crisis in 2008-9. Here, the worker-friendly labour market would constitute one of the best tools to make sure firms invest in productivity increases rather than just paying out excess profits to shareholders. By ‘deflating’ the strong labour market the BoE, like other central banks, is squandering this golden opportunity to solve the productivity problem. Instead, the orthodox low inflation policy will heap further misery on the population.
This week’s action by Andrew Bailey were clearly aimed at signalling to market participants that the lax monetary policy the Bank has adopted following the mini-budget will end and that interest rates will increase as was the plan before Truss became PM. By doing this, Bailey has further constraint the government’s leeway in terms of its fiscal policy. Given the tight monetary policy, a lax fiscal policy becomes unaffordable, and Bailey is thus de facto imposing austerity on the government. The new Chancellor Jeremy Hunt – whose economic policy views are much more closely aligned with Bailey’s than Kwarteng’s – has already hinted that the government will oblige and cut public spending.
This leaves the PM in a very precarious position. By sacking Kwarteng – who hours earlier had reassured journalists he would ‘be going nowhere’ – and appointing Hunt, she has essentially caved to market and BoE pressure and abandoned her economic strategy. The News Agent podcast rightly asked: What is the point of Truss then? Already during Prime Minister’s Questions on Wednesday had it become clear that her libertarian economic strategy was dead in the water. It was beyond ironic that the one thing that Truss insisted on when challenged by Starmer on what he called her ‘Kamikaze budget,’ was the cap on energy prices. Indeed, she answered every question about the mini-budget – including whether she agreed with Business Secretary Jacob Rees-Mogg that the market turmoil had nothing to do with the mini-budget – by referring to the energy price cap as the most important part of her mini-budget. That is beyond ironic, because the price cap is literally the only part of the mini-budget, which did not conform with Truss-Kwarteng’s libertarian ideology. It was adopted in the first U-turn of her premiership, breaking promises made during the leadership campaign.
She is now faced with a Chancellor who does not share her economic extremism, but adheres to a more orthodox conservative economic policy. His first public interventions clearly show that his economic strategy will directly contradict Trussonomics. Thus, he announced tax increases and spending cuts, when still on Wednesday the PM herself promised there would be no such cuts. It seems obvious that Hunt is now the person in control in the government. Indeed, various observesr treat Hunt as the caretaker PM in waiting, after Truss’s imminent demise next week.
Indeed, the damage Truss did to the UK’s and her own reputation are such that even her dramatic U-turns do not steady markets anymore. While the news that there may be a U-turn on the tax cuts led to a short-lived rally in UK government bond prices, Truss’s decision to sack Kwarteng and what she had to say about her plans in the press conference actually saw another hike in gilts sell offs, indicating that her government has lost any credibility.
Be that as it may, critiques like Prof. Richard Murphy – rightly – point out that from a democratic point of view, the unelected governor of the BoE preventing the government from carrying out its economic policy is highly problematic.
Except, of course, that in the case of the Truss government the story that a ‘bad’ technocrat prevents a democratically elected government from delivering an economic policy that the people have voted for does not hold. In fact, given that we have an unelected Prime Minister who pursues a radical economic strategy that none voted for, the government’s alternative policy preferences are no more democratically legitimated than Bailey’s. Neither is Truss’s alternative much better – and certainly not more worker-friendly (at least in the long-term) – than Bailey’s conservative drive for austerity.
Indeed, what we have witnessed playing out this week was a clash of two contrasting but equally bad economic policy visions. The BoE’s is an orthodox economic policy focusing on price stability and a balanced government budget. This approach includes the willingness to sacrifice economic growth and even force the economy into a recession to stabilise prices. Conversely, the government’s economic policy focusses on low taxation, and supply-side reforms and deregulation, but is relaxed about high public debt – at least in the short term – and accepts relatively high inflation to keep interest rates down with a hope to stimulate economic growth.
This week, markets have made it clear that they do not trust the latter vision in any shape or form and the government is little by little forced into one humiliating U-turn after the other in order to reassure markets. While that may be seen as a problematic dominance of markets over the political realm, the fact is that in this instance Truss’s vision would not have been better for the people in the UK than Bailey’s (and most probably Hunt’s) austerity vision. Indeed, what happened this week is that the waves of the financial markets have dragged the British people away from Truss’s pro-rich deregulation rock and smashed them right into Bailey’s austerity hard place.
TINA?
What is particularly worrying in the current context of bad economic policy making is that the dominant discourse in the media is still dominated by ‘there is no alternative’ (TINA) thinking. Thus, even the very moderate ex-Tory MP Rory Stewart defended on the Rest is Politics podcast Osborne’s austerity as the only option, even though we now know that it is literally a deadly economic policy. His key argument is that the only alternative to cutting public spending would be to borrow more, which he argues is not sustainable even when interests rates are low. That is a false dichotomy. There are of course alternatives.
The most obvious ones are tax increases. That option has become all but impossible for a politician to seriously suggest outside of a crisis situation (like the one we are facing). Ultimately, however, as Prof. Jonathan Portes has argued for years, we will have to get real about the need for tax increases if we want to maintain our public service. This may imply the need for a fundamental change to our tax system. Indeed, the current arrangement of relatively low taxes on corporate profits, on wealth, inheritance, and capital gains, but relatively high levels of tax on consumption (TVA) and incomes should be seriously discussed.
Similarly, in the discussion about inflation, unorthodox ways of fighting inflation need to be seriously discussed. These may include things like price controls, that Isabella Weber argued for in a Guardian column last year. Mainstream economists like Paul Krugman reacted furiously to that article, branding the idea ‘stupid.’ While I do not feel qualified to have an opinion on whether or not – and under what circumstances – price controls could work, the time for orthodox economists to confidently reject anything that’s outside the box should be truly over given the mess we find ourselves in.
Fear the Project
From a Remainer perspective, one positive outcome of the chaos of the past weeks is that it has now become all but undeniable what an utter shambles Brexit and everything it caused has been.
The best illustration comes from the Telegraph. While in September 2019 it still titled that the ‘success of Brexit has left Project Fear on its deathbed’ and in June 2021 trade figures were cited to show ‘just how wrong Project Fear really was,’ by July 2021 the tone started changing. While project fear was still declared to be wrong, readers were now told that the rewards of Brexit would take time to materialise. In an astonishing sign of how the worm has turned, a headline in today’s Telegraph read Project Fear was right all along. The Author Jeremy Warner writes:
“Downbeat predictions by the Treasury and others on the economic consequences of leaving the EU, contemptuously dismissed at the time by Brexit campaigners as "Project Fear", have been on a long fuse, but they have turned out to be overwhelmingly correct, and if anything have underestimated both the calamitous loss of international standing and the scale of the damage that six years of policy confusion and ineptitude has imposed on the country.”
Indeed, after years where Brexit was treated as a taboo by many, there seems to be an increasingly wide-spread consensus that the economic impact of Brexit has been an unmitigated disaster. This consensus not only includes academics and left-leaning journalists, but increasingly also bankers – e.g. Citibank’s Chief Economist.
The disaster is bound to get worse for the Tories, as the unorthodox economic policies adopted by Truss’s cabinet has wiped out one of the key bases of Tory electoral support, namely homeowners. Indeed, the looming mortgage cost crisis will leave millions of people saddled with massively increased mortgage payments. According to Resolution Foundation’s Torsten Bell for some families these increases could be up to 10% of household income by late 2024. These are millions of people who were more likely than the average to vote Tory before the mini-budget. Add to that the fact that according to the IMF inflation is expected to be higher and longer-lasting in the UK than in other countries, the situation is really dire for the Tories. Worse still, it is entirely self-inflicted. Not just because of the mini-budget, but more fundamentally because of David Cameron’s brilliant idea to hold an ‘in-out referendum’ on EU membership without the slightest plan about how Brexit would be achieved in practice.
The fabrication of a stab-in-the-back myth
Given the utter chaos and humiliation of the Tory party, it comes as no surprise that the usual Tory backers and especially its libertarian fringe are running for cover. The Spectator’s Kate Andrews defends the libertarian ideology underlying Trussonomics, and blames its obvious failure on ‘miscalculation and hubris’ on the part of those who implemented the ideology. Yet, I think Andrews‘ fears that Truss might drag free-market libertarianism into the abyss with her are unwarranted. We can already see a ‘stab-in-the back myth’ emerging around Truss’s bold attempt to put Britain on a libertarian economic course. Interestingly, Andrews finishes her article with a reference to the staple socialist defence of real existing socialism, which consist in insisting that real socialism has never been tried and all attempts so far were just perversions of the real thing. Andrews argues that defenders of Trussonomics may resort to the same type of argument. However, I rather get the feeling that it is the libertarians who disown Trussonomics now that it has so spectacularly failed, when only a few weeks ago they were still raving about how promising a start Kwarteng’s mini-budget was for the Truss premiership. Thus The Telegraph’s Alistair Heath still praises the wonderful mini-budget and argues that everyone else is responsible for its failure.
The libertarians may very well succeed in convincing enough people that the problems is not the prophecy, but the prophet and thus keep their corrosive ideology alive. At the same time, there has hardly ever been a better opportunity for those of us who strongly reject libertarian fantasies, to push and move economic thinking out of the realm of fantasy and wishful thinking into the realm of reality. For that to happen, however, we need the opposition parties to become more confident in the alternatives that they propose. If that happens, perhaps Britain can arise from years of chaos stronger and healthier than before.