The only way out of the UK’s fiscal impasse is to go into reverse

Warren Buffett’s adage that it takes 20 years to build a good reputation and five minutes to ruin it isn’t always true when it comes to the economy.

Sometimes a reputation for sound economic management can be earned in minutes, as Gordon Brown was delighted to discover when he made the Bank of England independent in 1997. Borrowing costs in the UK fell by around 0.5 percentage point and remained low. It was slow going wrong.

However, Liz Truss and Kwasi Kwarteng agreed with Buffett this time. It didn’t take looking back to know that it would be risky to implement the biggest unfunded tax cuts in 50 years, undermine the independence of the Bank of England, sack the respected head of the Treasury, mock economic orthodoxies and the Office for Budget Responsibility to be marginalized.

As I write this in Washington, Britain’s economic credibility on the international stage has noticeably diminished. I was asked with fascination, horror and pity how Britain could decline so quickly.

According to the Chancellor’s allies, this is all terribly unfair. The UK has the second lowest public debt burden in the G7, they say (using a silly definition). But it’s true that the UK’s public finances are generally stronger than those of Italy, Japan, the US and France, where debt burdens tend to increase every year and financial markets don’t seem to mind.

This is a very strange argument for right-wing libertarians. Instead of complaining and demanding handouts from the financial markets, they should take responsibility for their plight. The problem is that it is very difficult to find a solid solution to the UK government’s desire to combine large tax cuts with a reduction in debt as a percentage of national income in three to five years.

You can look at the always reliable Institute for Fiscal Studies analysis or my own calculations and you will get the same result. In March the government could have borrowed around £30bn more and the debt burden would still have come down. Since then, the economic outlook has deteriorated, interest rates and inflation have risen sharply, increasing the cost of servicing debt, welfare and pensions.

These effects more than wipe out that £30bn leeway. But on top of that, Kwarteng and Truss added at least £43billion a year in unfunded tax cuts. Add in a little extra defense spending and it’s very difficult not to leave a permanent hole in the public finances of around £60bn a year, or 2.5 per cent of national income.

What can ministers do to regain credibility? The OBR cannot credibly say that the economy will grow faster during an energy price shock, as it released simulations of a similar no-rebound scenario in July. The government could order the BoE to target nominal GDP growth of 5 percent a year, which would solve the public finance problem on paper. But that is tantamount to calling for almost 1.5 percentage points of additional inflation and would blow up the government bond market and send sterling crashing.

Ministers could promise spending cuts after the next election, but nobody would believe them. They could increase benefits by less than inflation but would not get that through Parliament. At a time when they had more credibility they could disagree with the OBR prediction and move on, but they wasted it and that option is gone now. The markets would panic.

There are only two things that will save Truss and Kwarteng’s commercial credibility. First, a great deal of luck that cannot be relied on. Second, to reverse any unfunded tax cuts in last month’s tax return. That’s the only option, now the financial markets have lost confidence in the prime minister and chancellor. For them, the political cost of an about-face would be enormous. But for the country there are only benefits. The only way out of the UK’s fiscal impasse is to go into reverse

Adam Bradshaw

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