Certain phrases from history remain timeless and Prime Minister Harold Wilson’s famous quip from the mid-1960s that ‘a week is a long time in politics’ has, arguably, never been more apt than over recent days and weeks. From dizzying tax U-turns to Britain's fourth chancellor this year, keeping up with the chaos is a skill in itself.
At the time of writing, Liz Truss is still PM, but new Chancellor Jeremy Hunt has ditched almost all of the tax cuts announced in the mini-budget three weeks ago as well as scaled back energy help. By the time you read this, who knows what else has happened.
In recent years the Office for Budget Responsibility has presented independent forecasts alongside Government budgets showing how cuts in taxation would be funded; the fiscal event on 23rd September presented by the Government was not accompanied by a forecast. So, to what degree was the lack of an OBR forecast alongside the mini budget a major cause of disruption in the financial markets?
No credible plan
‘Market actors…are uneasy about the higher levels of UK government debt, the implications for future inflation and the value of sterling. The lack of an OBR forecast merely confirmed their suspicions that the government does not have a credible plan to reduce public borrowing and national debt, as a proportion of GDP, over the medium term,’ says Phil Tomlinson, Professor of Industrial Strategy, Deputy Director Centre for Governance, Regulation and Industrial Strategy, University of Bath.
‘[The lack of an OBR forecast] is one of the causes but it was certainly not the only one,’ adds Miguel León-Ledesma, Professor of Economics at Kent.
‘There are two other causes. First, the announcement of permanent tax cuts without a clear plan on how they would be financed. Second, these were expansionary demand measures that clashed with the BoE’s current contractionary stance to lower inflation. This meant that the expected future increases in interest rates to tame inflation would be higher than previously assumed.’
The role of QE
León-Ledesma brings in the role of the Bank of England and its two mandates; Inflation control and financial stability. ‘QE was seen as necessary during the post global financial crisis period which was very persistent and deepened by the subsequent debt crisis in the Eurozone and the pandemic,’ he says. ‘This led to high gilt prices which led to a shift by pension funds from equity to gilts. This causes overexposure to the swings in that market. Here enters the financial stability mandate. It is perhaps in that area where the Bank may have failed to identify the systemic risk being accumulated in defined benefits pension funds. The two are obviously inter-related. But I prefer to see it more as a regulatory problem rather than a problem with QE per se.’
Is history repeating itself?
Observers have drawn parallels with the Barber budgets of the early 1970s when the then Conservative Chancellor, Anthony Barber announced huge tax cuts and higher public borrowing in a ‘dash for growth’. What, if anything, is different this time?
‘There are differences, of course,’ says Tomlinson. ‘Trade unions are weaker these days, and so are unlikely to be able to win inflation-busting wage rises – so for those in work, real wages are likely to fall (they rose during the 1970s). Moreover, in the mid-1970s, the UK joined the EEC which opened up trade and markets with its nearest neighbours. The majority of economists believe that over the long run, EEC (and then EU) membership had a positive impact on the UK economy.
Nevertheless, it is surprising that the (ex) Chancellor, Kwasi Kwarteng – who has a PhD in Economic History – ignored the lessons of the Barber budget. Afterall, the ‘Barber boom’ acquired textbook status of how not to engage in fiscal largesse.’
Lessons from the past
On the question of the importance of hindsight, if there are lessons that can be learned from history, what are they?
Tomlinson draws on two other memorable quotes from the past. The US economist Thomas Sowell’s declaration that ‘The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.’ And former Prime Minister Margaret Thatcher’s statement that ‘You can’t buck the market’.
‘Both these comments seem quite poignant right now!’ he says. ‘In the UK, there are also historical lessons for the Opposition parties – indeed, if the Labour Party wins the next General Election, it is likely to inherit an economic situation as dire as it was in 1974.’