Liz Truss ignored stark warnings from economists sympathetic to her growth strategy that the mini-budget which ultimately led to her downfall risked triggering a meltdown in the financial markets, the Guardian has learned.
Panty announced his resignation on Thursday after just 44 days in Downing Street, after a package of tax cuts and spending increases on September 23 sent markets crashing, pension funds ran and mortgage costs spiraled.
But days before the start of the premiership, she was told by economists Gerard Lyons and Julian Jessop that markets were very nervous and she could face a crash if her policy changes were not handled with care.
Lyons and Jessop – who supported Truss’ growth agenda – prepared a paper for a meeting at Chevening, the foreign secretary’s country residence, where Truss was, two days before she was announced as Boris Johnson’s successor on 5 September.
Also present was Quasi Quartengwho would be Truss’ chancellor, Matthew Sinclair, Truss’ economic policy adviser, and a third economist, Andrew Lilico.
The paper supported the idea that a new government must “get going” but repeatedly stressed the need to keep financial markets out.
It predicted the chaos that would follow Kwarteng’s unfunded £45 billion tax cuts announced in his September 23 mini-budget, saying: “Markets are nervous about the UK and about policy options. If immediate economic policy messages are mishandled, a market crash is possible .”
It suggested that the best policy option for the UK was to have higher interest rates from the Bank of England to tame inflation and tax cuts and spending increases from the Treasury to mitigate recessionary risks.
“However, financial markets are concerned that any fiscal easing could boost inflation,” the paper added. “In order to keep the markets out, it is therefore important that fiscal policy is clearly explained, that fiscal policy measures are now targeted and, in the future, focused on the supply side of the economy.
“There is a need to convince the markets that fiscal measures are necessary, affordable and non-inflationary.”
The hostile market reaction to the mini budget led to most of the tax changes being reversed before Truss announced her resignation. Kwarteng’s successor, Jeremy Hunt, is expected to be announced cuts in a fiscal statement still scheduled for Oct. 31, though that could change now there’s another Conservative leadership contest.
Jessop said on Thursday: “We were quite clear that the markets were very fragile and nervous. We said they had to move carefully and stage the process. We said there was a significant risk of a market crisis, and that’s what happened. The overall strategy was right. The handling of it was terrible.”
Jessop said the opportunity to deliver on the growth strategy had now been lost. “Supply-side reforms need a strong, committed prime minister. We’ve gone back to what we tried to avoid – a downward spiral of tax hikes, spending cuts and weak economic growth. A deep recession is now starting to look more likely.”
Neither Lyons nor Jessop discussed the mini-budget with Truss after she became Prime Minister, although Lyons again warned Kwarteng of the need to watch the markets in the days leading up to the September 23 financial event.
“I sent another message to the chancellor after reading in the Sunday Times that a stamp duty cut would be included as part of a mini budget. The papers made it out to be a much bigger event than the markets had expected, says Lyons.
He said markets reacted poorly to Kwarteng’s initial package, but what tipped them over the edge was his announcement two days later that more tax cuts were coming. “The markets were feverish and that should have reinforced the need to be more cautious.”
In their essay, Lyons and Jessop pointed to five policy challenges facing the new administration: “Managing the energy crisis; inflation and cost of living crisis; economic slowdown; departmental spending, especially in health care areas, as higher inflation will have reduced the real purchasing power of planned government spending; and the need to avoid an imminent financial crisis and pound crash by outlining policies to deal with the above.”
They added: “Fiscal responsibility is paramount – through a commitment to reduce the debt-to-GDP ratio over time, thereby ensuring solvency. Over time, public spending must be kept under control, with low tax rates.
– The fact that expectations for future economic policy and regulatory policy are low creates a great opportunity – but only if the new government strikes. The only way to confront the current situation is to act decisively and not to hesitate, thus sending a clear message to the public and the financial markets.”
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