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Government should stay the course on Trussonomics

Julian Jessop Julian Jessop is an independent economist. He tweets @julianhjessop

After all the fury of the past week, many will be tempted to write off “Trussonomics” as a mad experiment that has already gone badly wrong. This would be a mistake. Let’s start with the basics. The new Prime Minister and the Chancellor have already delivered on three of Liz Truss’s campaign promises. First, they have acted decisively to ease the burden of soaring energy bills on households and businesses. The Energy Price Guarantee could be hugely expensive, but it was perhaps the least bad solution to a looming economic and social crisis. We do not have to look far to see what might have happened without this measure. The energy price shock has already raised consumer price inflation to more than 17 per cent in the Netherlands. And the German government is having to seek EU approval for its own even bigger support package, potentially costing €200bn (£175bn).

Second, last month’s mini-budget fulfilled the commitment to cancel next year’s planned increase in corporation tax and to reverse the national insurance rises. Combined with the additional support on energy bills, this should prevent the deep recession that looked almost certain just a few weeks ago.

Third, the Government has begun a serious and far-reaching programme of supply-side measures, designed to attract investment, boost productivity, encourage more people to return to work or start new businesses, and raise the potential growth rate of the economy.

None of this explains why the mini-budget was received so badly. In my view, the negative response was largely due to the surprise announcement of the additional cuts in income tax, which went further than expected. The markets could have taken the rest in their stride.

This response is particularly frustrating. The additional tax cuts were hardly reckless. Many seem to have forgotten that Rishi Sunak had already promised to cut the basic rate of income tax to 19pc. This was simply brought forward by one year, to next April. Reducing the top rate from 45pc to 40pc is more controversial. But it is a sound supply-side policy. People on higher incomes, and the businesses that employ them, are especially likely to respond positively to tax cuts, for example by relocating to the UK.

Of course, if this were just about providing a quick boost to demand, it would make more sense to target support at those on lower incomes. But the upfront cost of the abolition of the 45p rate was only a tiny part of the overall package. The additional cuts in income tax were therefore the right policy, just at the wrong time. Markets were already jittery. It would have made sense to keep any further tax cuts back until the publication of the medium-term fiscal plan and the accompanying analysis from the Office for Budget Responsibility.

But what’s done is done. It would be wrong now to U-turn on any of the measures announced so far, which are all good policies, or for heads to roll. The worst that could be said of Kwasi Kwarteng is that he is an “unlucky general” who has lost the early skirmishes with the markets. He will learn from this. There are already signs that the markets are calming down. The pound has recovered a little against the US dollar. There are many reasons for this and not all of them are good, including expectations of larger interest rate increases in the UK and some poor economic data from both the US and the euro area. But at least sterling is no longer seen as a one-way bet.

Some calm has also returned to the gilt market, even though this required extraordinary intervention from the Bank of England. The yields on UK government bonds are still volatile and could rise further. But at least they are now tracking those in other markets again.

Nonetheless, this has been a bruising start, and the damage could linger. There is a danger that the recent turmoil will reinforce the groupthink that Trussonomics has sought to challenge, and overshadow the many positives. Inevitably, many are saying “we told you so”. This could have been avoided with a few small tweaks to the minibudget, or if global markets were not already spooked by fears over US interest rates and the energy crisis in Europe.

There is also a risk that anything bad is now blamed on Trussonomics, just as every economic problem since 2016 has been attributed to Brexit. For example, interest rates have been too low for too long, and the Bank of England should have raised them sooner. But when it does catch up, this will now be pinned on the Government.

There is also a danger that the old Treasury orthodoxy reasserts itself on government borrowing. A narrative is already developing that there is a need for big and immediate cuts in public spending to pay for big cuts in taxes. This is politically toxic, but also bad economics.

Instead, Trussonomics is about growing the economy, through tax cuts and supply-side reforms. This means that the burden of debt is reduced over time and that higher tax revenues can fund better public services. If this means that borrowing has to take the strain in the short term, so be it. It makes little sense to slash public spending now, or to penny-pinch on benefits, when the economy is still fragile and so many households and businesses are struggling. Sure, this might mean lower interest rates, but that would just be to get the policy mix wrong again.

A supply-side growth plan means that the Bank of England no longer has to keep interest rates at emergency lows in order to support demand. Yields should then return to more normal levels.

In short, the Government should stay the course. The big challenge now will be to avoid being captured again by the orthodoxy that Trussonomics is seeking to overturn.

‘Challenge now will be to avoid being captured again by the orthodoxy’

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2022-10-02T07:00:00.0000000Z

2022-10-02T07:00:00.0000000Z

https://dailytelegraph.pressreader.com/article/281552294742306

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