- After her tax-cutting plan caused chaos on the markets, Liz Truss, UK Prime Minister, has resigned.
- Truss dismantled most of the plan and fired her finance Minister, but markets remain nervous.
- This shows that today’s aggressive policymaking can confuse investors and result in lawmakers losing their jobs.
After the market response to Liz Truss’ aggressive tax-cutting plans, Liz Truss, UK Prime Minister, resigned. Fire her finance minister, Kwasi Kwarteng — all in the space of only a month.
Truss’s departure is a signal to other world leaders of how aggressive economic policies in this current climate can scare investors and cost lawmakers their jobs.
We take a closer look at the UK’s events and offer some lessons for other leaders.
Emergency action: Pounds, bonds, and dollars
Kwarteng’s “mini-budget”, which unfunded cuts to income taxes, corporate profits, dividends, was the catalyst for the firestorm that erupted on September 23.
Investors were concerned that the cuts would increase already high inflation, cause the Bank of England’s to raise interest rates more than they expected and create a hole in the national government budget. This could lead to an increase in inflation, a slowdown in economic growth, and a worsening of the UK’s cost to live crisis.
The British pound is quickly becoming a popular currency Record-breaking lowAs worried investors decreased their exposure to the US, yields on UK bonds (or “gilts”) rose against the US dollar.
The surge in gilt yields also led to a cash crunch in the pensions industry, as funds employing so-called liability-driven investing strategies — hedges against moving inflation and interest rates — were caught off-guard, to the point that some feared pension funds could collapse.
The Bank of England launched an initiative in response to the turmoil. Program for emergency bond-buyingThe goal of stabilizing trading and stopping further rises in gilt yields was achieved between September 28th, and October 14.
“If the market continues to dysfunction, there would be an important risk to financial stability,” stated the UK’s central banking. It also said that rising yields could cause credit problems for businesses and households.
Criticism mounts
Kwarteng, Truss, and Kwarteng’s fiscal plan roiled markets, rattled retirement funds, and fanned fears about a financial meltdown. International condemnation was swift. Rarely, the International Monetary Fund issued an official rebuke to warn the UK against compromising its fight against inflation by recommending a looser fiscal policy.
Ray Dalio (the billionaire cofounder and founder of Bridgewater Associates) said that the UK’s failure “to anticipate the brutal market reaction” was a result of its inability to do so.Incompetence suggests incompetence.” Nobel Prize-winning economist Paul Krugman declaredTrussonomics was called “deeply stupid” by Trussonomics and called the fiscal plan “cruel”.
Nouriel Roubini (an economics professor at NYU Stern) slammed Truss, her cabinet, and called them “clueless.” Mohamed El-Erian, Allianz’s chief economic adviser, warned the market mayhem raised the risk of “stagflation” — a toxic combination of stubborn inflation, stagnant growth, and increased unemployment.
Under pressure to collapse
Truss fired Kwarteng on Friday and appointed Jeremy Hunt — a veteran politician who has held several top government roles — as her new finance minister.
Hunt ran to assure the British public and markets that everything would be under control on Monday. He scrapped most of the planned tax cuts and suggested the Energy Price Guarantee — a government scheme to help households and businesses pay their energy bills in the coming years — could be gone by April 2023.
Hunt stated, “No government is able to control markets. But every government can assure the sustainability and viability of public finances. That is one factor that influences how markets behave.”
He said that although governments cannot prevent volatility in the markets, they can help to mitigate it. He also noted that instability has an impact on prices, mortgage costs and the value of pensions.
The government has now walked back about two-thirds of the £45 billion ($50.9 billion) tax cuts it initially planned, According to the Institute of Fiscal StudiesThe UK think tank,
Truss was forced to resign on Thursday by the public pressure.
“We set out a vision for a low tax, high growth economy – that would take advantage of the freedoms of Brexit,” she said in her resignation speech. “I acknowledge though that the current situation means that I am unable to fulfill the mandate under which I was elected to the Conservative Party.”
An alert for other leaders
Experiments in the UK have shown that aggressive policies can have serious consequences for markets.
Shifts of currency, bond and stock prices indicate where investors are most worried and what they anticipate to happen. These fears dragged down the pound and increased the government’s borrowing costs. They also put pressure on pension funds. Truss was forced, therefore, to reverse most of her plan and replace her finance secretary. She also had to step down as prime Minister.
“Investors understand that the political chaos which has defined the UK through 2022 is not over,” Nigel Green CEO of DeVere Group stated in an email statement.
“The pound, the gilt markets, and others will remain under pressure for foreseeable future,” he said.
El-Erian Tweet on Monday: “It’s interesting to hear that some European officials are welcoming the ‘demonstration effects’ of the UK policy U-turn, seeing it as vividly illustrating to some EU member countries the danger of fiscal slippages.”
One key takeaway is that of a Period of high inflation, stagnant economic growth and increasing geopolitical tensionsLeadership can be limited in their ability to make good decisions.
Although raising rates might cool inflation, it can also lower people’s wealth by decreasing their property values, investment portfolios and other assets. This can also lead to increased unemployment. Let inflation run amok can make goods and services more costly and make it difficult for investors to get real returns.
UK leaders thought they could grow their way out of trouble by slashing taxes — but were swiftly rebuked by skeptical investors. Their counterparts abroad will be cautious about provoking the markets and putting themselves at risk.
