Tangled up in Blue. A Hard Rain’s Gonna Fall. Desolation Row. In a way, it was a shame none of these songs featured in Bob Dylan’s set at the London Palladium on the day Liz Truss announced her resignation because all three would have been captured the mood.
The opening song from Blood on the Tracks aptly sums up the state of modern Britain after 12 years of Conservative rule. This is a country that is increasingly dysfunctional and, from the outside, appears to be having a nervous breakdown.
In the latest twist to this blue psychodrama, Rishi Sunak is strong favourite to replace Truss but is being challenged by Boris Johnson, the prime minister he was instrumental in removing from office less than two months ago.
Make no mistake, a Sunak premiership would be a victory for the financial markets and for the status quo more generally. And not just in Britain, either. After Truss’s humiliation during her 44 days in office, any country contemplating challenging the orthodoxy will now be having second thoughts.
This is a disaster, but one that Truss and Kwasi Kwarteng brought on themselves. As the Guardian revealed, the prime minister and her first chancellor were warned last month by economists sympathetic to their project of the need to square off the markets before revealing the contents of the mini-budget.
There was – and still is – a respectable case for the government borrowing more at a time when the economy is weak but the reasons for pursuing a more active fiscal policy needed to be spelled out. Truss and Kwarteng were told this by Gerard Lyons and Julian Jessop at a meeting in early September but chose not to listen.
The way forward was obvious. First, the Truss government should have announced details of a six-month energy price cap, an appropriate response to the hit to real incomes caused by Russia’s invasion of Ukraine. Other European countries had already announced price controls in response to higher gas prices and there was no reason why the markets would have been alarmed by a similar UK plan.
Second, Kwarteng should have announced a date for a later fiscal event at which he would make good on Truss’s leadership promises: the cut in NICs and the scrapping of the corporation tax increase, with the moves costed by the Office for Budget Responsibility. Any further changes should have been parked until a full budget in the spring of next year, again with an OBR assessment.
Instead of this step-by-step approach, Truss and Kwarteng committed blunder after blunder. All three stages were telescoped into one, the OBR was sidelined and the story became less about protecting the public from the side-effects of Putin’s war than about borrowing for tax cuts for the rich. The prime minister and the chancellor seemed surprised by the hostile market reaction but they really should not have been.
Now a hard rain is gonna fall. Kwarteng’s replacement as chancellor, Jeremy Hunt, is preparing a package of swingeing spending cuts and tax increases that will suck demand out of an economy already in the early stages of recession. In this he is being egged on by the International Monetary Fund, which thinks it is a good idea for both monetary policy – what the Bank of England does – and fiscal policy to be tightened at the same time.
But the idea should be to use a combination of monetary and fiscal policy to bring inflation down with the minimum amount of collateral damage. At a time when the Bank is in danger of being spooked into over-aggressive increases, it would make sense for the chancellor to be pushing in the opposite direction. The upshot of having monetary and fiscal policy pushing in the same direction will be an increase in company failures, higher unemployment and weaker consumer demand. The recession will be deeper and longer, making it harder for the government to meet its targets for borrowing and debt.
When Truss was running to be prime minister, she pushed back against the idea that there was a quantifiable “black hole” in the public finances that could be filled only by tax increases or spending cuts, and she was right to do so. Estimates of the public finances in the future rely on assumptions about how fast the economy will grow, because faster growth means a higher tax take, lower spending and smaller deficits.
The incompetence and chaos of Truss’s brief period in office means that any hope, for now at least, of an alternative to deflationary policies has been extinguished. Both the Bank and the Treasury now feel obliged to pursue what they see as market-friendly rather than people-friendly policies. In tough times, the state can act as a shock absorber by spending and borrowing more, but Hunt thinks he has no choice but to make the public absorb more of the shock itself.
In those circumstances, people act rationally. They spend less and save more; businesses find they have fewer customers and respond by cutting back on investment. Unemployment rises and companies go bust.
The fact that there are people on the left as well as the right who insist that Hunt has no choice other than to usher in a new age of austerity is evidence of the harm that Truss has caused. Governments always have choices, and this one has decided that a period of fiscal discipline is now necessary.
Hunt will get the full backing of whoever becomes PM for policies that will lead to more people relying on food banks and shivering in their homes this winter, fearful of turning the central heating on because of the cost. Desolation Row is about to become more desolate.
