Sunday, September 25, 2022
Welcome to Kwasi's world of push me-pull you economics
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

Readers with long memories may recall a time when chancellors would announce hikes in interest rates during their budget speeches. This, in the time before Bank of England independence, was usually when the economy needed some nasty medicine, so a rise in interest rates would typically be accompanied by tax hikes, and vice versa.

The past few days have seen something rather different. On Thursday the Bank of England increased Bank Rate from 1.75 to 2.25 per cent, its seventh in a row and the second half-point rise in succession. Until last month, the Bank had never raised by more than a quarter during the independence era, which dates back to 1997.

It could have been more. Three of the nine members of the Bank’s monetary policy committee (MPC) wanted to hike by three-quarters of a percentage point, 75 basis points. While not anticipating Friday’s maxi-budget from Kwasi Kwarteng, they said that the policy of freezing energy prices, at considerable cost to the public finances, “would add to demand pressure” and thus make the task of getting inflation back down even harder.

Then, on Friday, along came Kwasi with the biggest tax-cutting budget since Anthony Barber 50 years ago, according to the Institute for Fiscal Studies. Having leaked part of his statement on Thursday afternoon, revealing that his national insurance (NI) cut would come into force on November 6, a little earlier than expected, he then unveiled a lot more. The Bank would have been prepared for that, and the decision not to go ahead with next April’s planned rise in corporation tax, adding up to a combined £34 billion when fully in place.

More surprising was the other £11 billion of tax cuts, some bonkers, some provocative. Cutting stamp duty is the least sensible use of taxpayers’ money I can think of, at a time when house-price inflation is in double figures and residential transactions are holding up well.

Abolishing the 45 per cent additional rate of income tax – a legacy of the financial crisis – at the same time as lifting the cap on bankers’ bonuses was a combination that the Treasury’s Sir Humphrey, Sir Tom Scholar, would have described as “brave” if he had not been sacked. The 45p rate abolition, which I got wind of a couple of days before the announcement did not cost that much, roughly £2 billion a year, but is hugely symbolic. Together with the move on bankers’ bonuses, it is intended to boost immigration, of international bankers that is. There is still, of course, a higher income tax rate than 45 per cent in the system, the 60 per cent marginal rate that applies on income between £100,000 and £125,140.

Bringing forward a planned cut in income tax to 19p in then pound (from 20p) to April next year is an unashamedly political move but, in tax terms, entirely illogical. The Office of Tax Simplification is being abolished, which is perhaps just as well. Cutting the basic rate of income tax, always the obsession of chancellors from both parties, is a strange thing to do when income tax is being increased through the mechanism of freezing tax allowances and thresholds. Even so, bringing forward the income tax cut at a time when inflation is expected to be still close to double figures will boost demand at a time when the Bank is trying to constrain it.

This a curious state of affairs. You may be familiar with the Pushmi-Pullyu from Dr Dolittle, a strangle, llama-like figure with a head and shoulders at each end of its back. What we are seeing from the new prime minister and her chancellor is push me – pull you economics. The Bank is trying to restrain demand by raising interest rates, while the government is pumping it up with tax cuts and untargeted energy support.

As Lord Macpherson, the former Treasury permanent secretary, who has just seen his successor unceremoniously dismissed, put it: “Historically, the role of UK fiscal policy was to support monetary policy. Now it is to oppose monetary policy. Perhaps, that explains why the long-term cost of borrowing has risen …. We are already paying the price.”

Martin Weale, the usually cautious former member of the MPC and director of the National Institute of Economic and Social Research, warned on Bloomberg TV that the policy conflict and the decision to proceed with large-scale tax cuts would “end in tears”, and could trigger a run on the pound, raising the spectre of the International Monetary Fund bailout of the UK in 1976.

Is there any logic to this push me-pull you economics, apart from the inevitable end product, which is that interest rates will have to rise further and faster than would otherwise be the case? The markets, judging by first impressions, think not.
Sterling plunged after the chancellor’s speech and gilt yields – the cost of government borrowing – recorded one of their biggest increases on record. Markets were looking for credibility, and they did not find it in these announcements.

To be fair to the government, by making the energy price freeze untargeted, albeit at great cost - £60 billion over the next six months alone - Truss has ensured that measured inflation will not rise by too much from current levels. Even the Bank’s hawks say this will restrain inflation expectations “but was not necessarily sufficient to do so alone, given inflation would still be very high for several months”.

To be fair to the chancellor, too, his maxi-budget was not just about a short-term demand boost. The “medium term” is the new sunlit uplands. Growth, he said, would not happen overnight but via the 2.5 per cent target for trend growth in the medium term. The medium term is also when government debt will also be brought under control, he claimed, falling as a percentage of gross domestic product, after first rising sharply.

In a letter to the Bank governor Andrew Bailey before his statement, the chancellor said he was “unashamedly” focused on growth, “which will build stronger capacity to alleviate inflationary pressures”. In the medium-term again.

If we can wait for that medium-term, some of the things he flagged in his speech, which will be works in progress for some time to come, could make a difference. We should be now have learned the lessons of enterprise zones, and ensure that the new, low-tax and low-regulation investment zones create economic activity rather than just pinching it from elsewhere. Measures to speed up the planning process for infrastructure projects could also help, though this has been talked about a lot in the past, with little progress, and need t eb accompanied by meaningful planning reform for housebuilding.

The challenge will be to convert all these ideas lifted from the right-of-centre think tanks into a meaningful plan for growth. The bigger challenge, in the short-term, is to convince financial markets that this is not just a wild excursion into Truss dreamland, a massive gamble with the nation’s finances.