A Remainer coup has taken over Britain’s economic policy – The real risks to the economy now come from the Remainer elite, both at home and abroad
Liz Truss’ economic policy was actually very clear. It had three parts. The first was to allow monetary policy to reduce inflation and, by raising nominal interest rates, allow real interest rates to turn positive again – something they had not been since the financial crisis. world. (Long-term negative real interest rates are unsustainable as a long-term equilibrium – they discourage saving which is the only source of long-term investment and inefficient zombie firms are kept in business so that the resources they use should be reallocated to more productive uses.)
The second was to allow fiscal policy to stabilize the economy and prevent a recession. The third was to introduce supply-side reforms to increase investmentto build Infrastructurepromote innovationand providing appropriate incentives through tax cuts and smart regulation – the result would be higher real incomes due to resulting productivity improvements.
It was the economic policy desired by Brexiteers since the UK left the European Union. However, the remaining elite, both at home and abroad, were determined that Brexit would not be a success and did everything in their power to destroy it.
Kwasi Kwarteng, the Chancellor of the Exchequer who announced the supply-side reforms in the ‘mini-budget’ on September 23, did not help himself by explaining how the tax cuts were going to be financed at a moment of heightened financial uncertainty caused by the global energy crisis and the war in Ukraine. Then there was the dismissal of the Permanent Secretary to the Treasury on his first day in office and the refusal to obtain projections from the Office for Budget Responsibility (OBR) on the impact of tax cuts on public finances. . There were understandable reasons for this – explained below – but it came across as hubris.
Bond and money markets reacted badly to the announcement and, smelling blood, anti-Brexit media like the BBC went into overdrive to try and force the Chancellor and Prime Minister to quit – as they had done successfully with Dominic Cummings and Boris Johnson.
The International Monetary Fund quickly joined the fray. Maurice Obstfeld, former chief economist of the IMF, said ‘Fears over fiscal dominance are real given the way the UK government performed in this episode. A lot of damage has been done. It was unwise to deploy tax cuts without the necessary analysis and respect for institutions. The message was that ideology trumps everything else. This is the wrong historical moment for neo-Thatcherism”.
This was immediately followed by IMF Managing Director Kristalina Georgieva, who deliberately misunderstood the first two prongs of Truss’s economic policy by announcing that ‘fiscal policy should not undermine monetary policy because if it does, the task of monetary policy becomes more difficult and results in the need to further increase the [interest] rates and tightening of financial conditions. When monetary policy brakes, fiscal policy should not step on the accelerator, because if it does, we are in a very dangerous race”.
Recall that it is the same IMF which in 2016 lowered its forecasts for global economic growth following the Brexit vote: ‘The Brexit vote implies a substantial increase in economic, political and institutional uncertainty, which is expected to have negative macroeconomic consequences, particularly in advanced European economies‘. Obstfeld, who was the IMF’s chief economist at the time, said: “Brexit threw a spanner in the works‘ and predicted that the UK would experience the largest reduction in growth among advanced economies.
This view was in line with HM Treasury (HMT) forecasts at the time. You will recall that it was the HMT model that predicted that the “extreme shock” of the UK’s exit from the EU in 2016 would cause a recession with GDP falling by 6% and unemployment rising by 520 000.
However, there was no recession after the Brexit vote. Indeed, the economy grew by 6% between 2016 and 2019 (the last year before the Covid pandemic) and unemployment fell to 3.8%. The UK government budget deficit decreased between 2016 and 2019, from 3.3% of GDP to 2.4%. I strongly criticized the HMT model in “Making Astrology Look Respectable: On the Extraordinary Abuse of Economic Models in the EU Referendum Debate”.
The real concern now is that the OBR model will be used to trash Truss’ economic policy and bring government economic policy back to Treasury orthodoxy. Economists who follow the model closely say that the main forecast is overridden by a productivity assumption (which simply reflects bad recent experience) and the business investment forecast is adjusted to make it all add up. The forecast balance sheet of the OBR is not particularly precise. This may be the reason why Kwarteng did not want to use the OBR model.
Jeremy Hunt, who replaced Kwarteng as chancellor ‒ rumor has it the Treasury announced he had been fired ‒ said the mini-budget went “too far too fast”. He announced that most tax cuts will be reversed and public spending will be cut – and he will rely on the OBR’s forecast to ensure that the government’s economic policy is sustainable.
Yet no serious scientific discipline would rely on the results of a single model. Scientists understand the concept of “model risk” ‒ no model can capture all the nuances of the real world being modeled ‒ so good scientists always look at the results of a variety of models.
The Chancellor should ideally look at forecasts from other macroeconomic models as well as the OBR model. But that won’t happen.
And that’s exactly what the Remainers of HMT want. They now have the chancellor entirely in their hands. He is also now a captive of the Bank of England. Andrew Bailey, the Governor of the Bank, warned against a significant increase in interest rates: ‘We will not hesitate to raise interest rates to achieve the inflation target. As things stand, my best guess is that inflationary pressures will require a stronger response than perhaps we thought in August.”
So over the past few weeks the whole of UK fiscal and monetary policy has come under the control of Treasury and Bank of England orthodoxy – just look at the composition of the new economic council of Hunt – and the growth program was effectively abandoned. In fact, the opposite will happen: the combination of tight monetary and fiscal policy will cause a recession.
The so-called ‘anti-growth coalition’ is delighted, including President Biden with his ice cream, faithfully reported on BBC News. Labor said in the mini-budget that tax cuts benefit the rich more than the poor. The clear implication is that we can never cut taxes again – since the wealthy will always benefit relatively more from lower taxes and we can’t have that when the poor are lining up at food banks. Now taxes will only go up – and that will do nothing for productivity. Anyone who makes a profit can now expect a windfall tax.
We therefore face a future with no productivity improvements and no real growth – productivity and real wages have barely increased since the GFC. Instead, the future will be one of redistribution. Obstfeld said it very clearly: “The whole Covid experience has put a strain on social cohesion and people are going through very difficult times. Economists are now more attentive to the distributive effects of crises”.
The implication of this is very clear. In the future, there will only be an illusion of growth with ever higher taxes on the better off paying higher employment benefits for the less well off. And if the Greens or the Liberal Democrats come to power, they will impose a tax of 1% a year on people’s homes – confiscating wealth from the private sector for the next 100 years.
The real risks to Britain’s economy now come from the remaining elite, both at home and abroad. They will soon suggest that since we are so useless at running our own economy, we should join the single market, the customs union, Schengen, the European army and the euro.
Professor David Blake
Faculty of Finance
Bayes Business School