Kwarteng and Truss show the perils of disregarding economic institutions

It would be an understatement to say that the last few days have been eventful for the UK’s economic and political watchers. Harrowing might be a better description, and that will certainly have been the case for the many people worrying what market turmoil might mean for their personal finances. Kwasi Kwarteng’s statement on Friday was not well received, and that negative reaction has only worsened. The pound has fallen, gilt yields have soared, and the Bank of England was forced to make a highly unusual emergency intervention to protect pension funds.  

That reaction has been an indictment of the new prime minister, Liz Truss, and her chancellor's approach to their Growth Plan. We argued last week that the policies announced represented a big gamble. But regardless of the wisdom of the tax cuts themselves, the process the government has followed and the disregard it has displayed for the UK’s economic institutions have threatened the UK’s fiscal credibility. Those institutions, including the Office for Budget Responsibility (OBR), the Treasury and the Bank of England, are not perfect, and it is open to politicians to announce policies that many in those institutions might disagree with. But Truss has allowed her suspicion that these institutions would challenge her plans to blind her to the wider importance of involving them in government decision making. The markets at least have judged this to be a bad mistake. 

The government made a point of ignoring the Treasury and OBR

The government did not follow many of the usual processes when developing its mini-budget. For a start, this was a radical and extensive package of tax measures delivered less than three weeks into the prime minister’s term. This is not enough time for such consequential policies to be stress-tested or for the chancellor to take on the advice of Treasury civil servants, who have a wealth of experience and expertise. There was no need for these policies to be announced so quickly, and most only take effect from March. A budget in late November would have afforded more time to adapt and improve policies while also placing them in the broader fiscal context.  

Upon taking office, one of Truss’s first acts was to fire Treasury permanent secretary Tom Scholar. Given what followed, it is reasonable to assume that this decision was linked to his opposition – revealed or anticipated – to the government’s approach. Rather than than seek to seek understand the Treasury’s head civil servant’s view on the merits of the plan, or take on his advice for how to manage the policy, ministers’ approach was instead to remove the obstacle and assume that anyone espousing “Treasury orthodoxy” would be of no help in their pursuit of a different economic agenda. By doing this and then moving so quickly, Truss and Kwarteng indicated their intention to sideline and undermine the Treasury and its advice rather than work with it. 

Truss and Kwarteng also deliberately sidelined the OBR, the government’s official and independent forecaster. The OBR offered an updated economic and fiscal forecast that would have allowed the chancellor to set out how his new policies fit within his broader fiscal plans. Inexplicably, he refused this offer, preferring to announce tax cuts free from the apparent strictures of needing to make the numbers add up. 

These decisions have formed a consistent pattern of ministers choosing to go it alone and avoid any constraint or criticism from “orthodox” institutions. The events have followed show that this was a bad miscalculation.  

The process, as much as the policy, is undermining the UK’s fiscal credibility

As the Institute’s initial reaction to the statement highlighted, the policies Kwarteng announced seem unlikely, based on the evidence, to deliver the intended improvements to growth. And £45 billion worth of tax cuts would be difficult to reconcile with the government’s current fiscal rules without substantial spending cuts for public services that cannot absorb them while maintaining service quality. However, the chancellor’s choices would not have triggered quite the same adverse reaction if he had set them out in a different way. 

These tax cuts will not be easy to reconcile with sound fiscal management. But on their own, you would not ordinarily expect these policies to have generated such a large market reaction. The UK is not in an especially weak fiscal position internationally, with a lower debt burden than most other countries in the G7 and with access to cheap finance for most of the past 12 years. 

But the process the government has followed has done as much, if not more, to put the UK’s fiscal credibility at risk. By announcing the tax policies in a vacuum, without new forecasts, new fiscal rules or accompanying spending decisions, the chancellor gave the impression that he did not recognise the trade-offs inherent in tax and spending policy and gave no indication of how these plans might be reconciled. As a result, government fiscal policy is unmoored from the usual process that ensures UK fiscal credibility is always explained and acknowledged. This was worsened by ministerial rhetoric, even after a negative market reaction, doubling down and promising even more tax cuts.  

The Bank of England’s actions show that economic decisions are easier with credible institutions 

Just a few weeks ago debate was raging around Truss’s campaign trail comments about the Bank of England, questioning its mandate and even its independence. The prime minister will be glad that she instead pledged to protect the Bank, as this crisis would be much more serious were it not a credible, independent and dependable institution. Its intervention in the gilt market yesterday is a prime example, as it was able to step in while ministers refuse to acknowledge there even is a crisis to avert.  

None of this means that our economic institutions are perfect or that their assumptions should not be challenged. The Bank can err in its decision making, the OBR will make debatable forecast judgments, and by no means are all criticisms of the Treasury’s orthodoxy and conservatism unfounded. Respecting their role and independence does not mean subjugating ministers’ will to those of technocrats. But there are ways to challenge the “orthodoxy” that Truss has railed against by engaging with these institutions, embracing scrutiny and looking to win the argument – playing by the “rules of the game” – rather than seeking to silence and sideline.  

There will be many difficult economic decisions to make in the coming days, weeks and months. Kwarteng and Truss must first recognise, quickly and publicly, that there is a crisis to address. For their own sake and for the credibility of the UK’s financial standing they should also acknowledge that the UK’s economic institutions are vital national assets. Accepting their role will make the next few months much easier to navigate.