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If Sunak and Hunt don’t change course, we are heading for severe recession

The collapse of Liz Truss’s mini-budget and the subsequent collapse of her administration risks causing serious damage to the UK’s economy in the long run.

The new regime of Rishi Sunak and Jeremy Hunt is on their way to learning all the wrong lessons from the turmoil in the markets, which brought down their predecessors and led to a sudden and futile change in policy.

Truss was right to prioritize growth, her description of tax cuts and supply-side reforms – all aimed at getting the economy moving and thus boosting production, jobs, expanding businesses, and ultimately tax revenue for public services – was correct.

The tragedy was that she and her advisor Kwasi Koarting failed to produce the documentary evidence that would reassure markets that the tax cuts would be covered by faster growth. Poor presentation and communication proved their downfall.

The danger is now grave. Sunak and Hunt are set on a path that will turn a stagnant economy into a shrinking economy, with unemployment rising, businesses shrinking, and the quality of public services further deteriorating.

The whole idea of ​​a growth agenda has become tragically toxic. The path we’re on now – fiscal tightening (tax increases and spending cuts) as well as monetary tightening (higher interest and mortgage payments) – has been tried before and always leads us into the scorched earth of higher taxes, further spending cuts, and a decline in living standards.

Politically, the outlook is bleak for the Conservatives. If Snack and Hunt continue to press ahead with their November 17 fall statement with a triple whammy of tax increases, spending cuts and higher mortgage rates, the state is unlikely to forgive them.

The story being told by the current consensus of UK policy makers and market economists is that the recent mini-budget has pushed the UK’s creditworthiness to dire levels, due to fears of budget profligacy. This reading of events severely exaggerates credit risk in the UK. The UK’s five-year CDS interest rates (which estimate the risk of a country not repaying its debt) have not moved in recent months outside France.

The main reason for the rise in gold prices that destabilized the Truss administration was the shift in expectations of interest rates set by the Bank of England in the future.

So what we need today is the return of good monetary policy along with well-crafted fiscal policy. The market expectation of rising inflation in the UK that the bank supposedly needs to respond to with those high interest rates can now be considered very bleak: inflation will fall on the back of a collapse in commodity prices as the global economy slows.

The main implication of these events is that they do not justify avoiding public borrowing: the UK’s credit reputation remains strong, with interest rates now expected to not exceed 3 per cent.

While Truss’s management has been very insensitive to the possibility of market opinion reacting adversely to borrowing policies, the current government is turning to the opposite extreme and seeming too sensitive in planning to borrow little or no borrowing at all, should market opinion decline.

The policies that have been reported to be planned are woefully inadequate to the UK economy in its current state. It will exacerbate a growing recession and lead to lower growth in the long run.

The Treasury is pushing for “additional taxes” to offset the decline in revenue caused by the recession caused by its contractionary policies. This thinking causes a “cycle of doom” as rising taxes chase a declining economy, causing tax revenue to continue to fall. Treasury doctrine turns into sado masochism.

Higher corporate tax rates and higher marginal income tax rates punish incentives for entrepreneurship and reduce our international competitiveness.

As Truss acknowledged, we need to transition to a reformed tax system that maximizes growth. This involves keeping tax rates low by borrowing until the policies pay off in the form of higher growth. From this point on, the debt/GDP ratio will go down and the borrowing will be paid off. Hunt/Sunak’s “cautious” policies that impede growth mean that this will not happen.

After the Truss-Kwarteng budget, the bank was able to create significant cash tightening by allowing, and even encouraging, long-term interest rates to rise in anticipation of raising interest rates to dizzying levels. This happened late in the day, when the global economy was already slowing sharply due to severe and rapid monetary tightening by most of the global central banks led by the US Federal Reserve. Money supply growth has now fallen to nearly zero in most countries, including the United Kingdom.

With commodity prices now low and demand collapsing, inflation here and elsewhere next year is likely to drop to 5 percent or less.

The bank now needs to ease the monetary pressure. It can do this by continuing to raise bank interest rates to around 3 percent but also by using quantitative easing to bring rates down at that level, indicating that he does not see the need to raise them much more. In this way, it confirms its intent to counter inflation while mitigating the monetary defect that is currently stifling the economy.

Politics can still avoid plunging the UK economy into stagnation and indefinitely low growth. But it needs to quickly change course to do so.

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