The writer, a former permanent secretary to the Treasury, is a visiting professor at King’s College London
The story of the British economy is one of slow but steady growth punctuated by disasters. Few were as big as the Barber boom.
In the early 1970s, Anthony Barber, the then chancellor, sought to unleash Britain’s growth potential through unfunded tax cuts and easy credit. Output briefly soared before hitting a wall of high inflation, industrial unrest and an oil crisis. When I joined the Treasury in 1985, senior officials still shuddered at the mention of his name. His boom was seen as triggering the series of policy errors that led inexorably to Britain’s emergency loan from the IMF in 1976.
It generally takes two generations for the British state to repeat a serious policy blunder. Kwasi Kwarteng’s “mini” Budget of last week proposed the biggest tax giveaway since Barber’s in 1972. Now as then, the chancellor is seeking to unleash growth. And he has done it at a time of full employment and high inflation. To orthodox economists, that seems brave if not foolhardy. It is little wonder that, in the days that followed, sterling fell and the cost of public borrowing rose. The chancellor had broken the cardinal rule at times of market stress — which is not to allow the UK to appear an outlier compared with countries of a similar size. The IMF was even on hand to issue a somewhat eccentric statement criticising his measures.
This was never going to be an easy time to sell a bold policy. The foreign exchange markets have been fragile over the summer as the dollar has strengthened. Central banks have been tightening policy, and the price of sovereign bonds has fallen as the markets have revised up interest rate expectations. Sterling was already in the markets’ sights: the Conservative party leadership campaign did not inspire confidence. But the speed, style and scale of the “mini” Budget took the markets by surprise.
The chancellor did not help himself by sacking his respected permanent secretary in his first week in office. Refusing to commission a forecast from the independent Office for Budget Responsibility was an elementary error: that would have been an opportunity to show how his numbers added up. And for all the talk of regular meetings with the governor of the Bank of England, monetary and fiscal policy are clearly out of sync. Kwarteng came across as a man so confident in his own judgment that he doesn’t listen to others. By Tuesday, the market in government bonds had seized up. It took an emergency intervention by the Bank of England to stabilise it.
As the pound and gilt rates gyrate, it’s tempting to think there will be a day of reckoning, as when sterling was ejected from the European exchange rate mechanism in 1992. But those hoping for such an outcome will be disappointed. Why?
First, the UK remains fundamentally solvent. The nation’s debt stock has risen in recent years, but it still compares well with other G7 countries. Second, floating exchange rates are much more firmly embedded than in the 1970s. Exchange controls are a distant memory, and the sterling foreign exchange market is deep and liquid.
In the months ahead, the pound may break parity with the Swiss franc or dollar. The symbolism would no doubt be humiliating. But the impact will be the same as every other devaluation. Over the past 75 years, Britons have seen the pound fall from $4.03 to the recent low of $1.03. They may be poorer as a result, but they take it in their stride.
Third, unlike in the 1970s, the Bank of England is independent. Its remit is to stop inflationary booms. The markets are now predicting steep rises in interest rates. The bank has a reputation to maintain: if fiscal policy is looser, it has to tighten monetary policy. This “push-me-pull-you” policy will prove expensive for mortgage holders, businesses and taxpayers.
The BoE may have bought Britain’s debt to stabilise the market this week, but only the week before they announced they would be selling it. This is an unstable equilibrium, which only the chancellor can address by proving his policy is not as expansionary as it appears.
Kwarteng has committed himself to publishing a medium-term fiscal plan on November 23. He should bring this forward. He will be required to announce some fiscal rules. But what matters is the substance: how he will stabilise and then reduce public debt as a share of national income.
If spending cuts are to finance his tax cuts, then his plans must contain credible announcements. Simply stating that the real wages of public sector workers or the benefits of the poor will be cut year after year is not sustainable. He needs to demonstrate how the NHS can deliver the increase in activity necessary to cut waiting times, without increasing spending further. He needs to explain how the inevitable increase in debt interest payments will be funded. If his spending plans aren’t credible, he will need to revisit his plans on tax. If he can also add substance to his promising ideas for promoting growth, for example on planning, so much the better.
Governments learn from their mistakes. Kwarteng could yet defy his critics and restore Britain’s economic credibility. But if he can’t — in a week when the leader of the Labour opposition has embraced “sound money” — there will be others who can.