Economic Turmoil Explained

 by Abhyuday Singh & Jack Nay

On 23rd September then-chancellor, Kwasi Kwarteng, delivered a ‘fiscal event’, known as the Mini-Budget. It was intended to stimulate economic growth and increase UK GDP through tax cuts. However, the proposal would have required that these tax cuts be “paid” for by borrowing money, which would have increased the United Kingdom’s national debt. This caused economic turmoil and had a vast array of consequences. The main points of the mini budget include: the basic income tax rate cut by 1p to 19p, the top income tax rate of 45p to be scrapped, the 1.25% national insurance rise to be reversed, limits on bankers’ bonuses to be scrapped and the planned rise of corporation tax from 19% to 25% to be scrapped.

The delivery of the Mini-Budget shocked worldwide foreign exchange investors, as the increasing budget deficit would also contribute to higher inflation levels. This is important for foreign exchange investors, as higher inflation will result in the erosion of investments made in pounds. Therefore investors will take their pounds out of the British economy, diminishing the value of the pound. As of 2022 the pound has hit a record low against the dollar, now worth $1.033, for the first time since 1985. Due to the fall of the pound, domestic businesses started to panic, as now the price of imports and imported energy will increase. This means that there will be higher prices and lower sales, reducing the amount of profit for businesses. The Bank of England in turn announced that “Further rate rises are very likely” to control that inflation, which has now led to a mass consumer panic, as some may struggle to accommodate the rise of mortgage rates. Additionally, economists predicted consumers will develop a higher marginal propensity to save, resulting in a falling in GDP, putting the British economy on a path toward a recession.  

A secondly, equally important factor was that bond investors reacted negatively. This was because of the notion that the British Government cannot afford the tax cuts, so they will need to borrow more money, therefore it will need to increase interest rates. As a result, British bond prices fell, as no one wanted them, which led to an increase in the yield of bonds, thus incurring increased borrowing costs for the government. Due to this, pension funds were on the brink of collapsing, as the value of their bonds were lower, which prompted the Bank of England to step in and bail them out.

Evidently, very few people liked the Mini-Budget and its consequences, which resulted in lots of pressure to mount on the government. For example, backbenchers of the Conservative Party threatened to block the passing of the abolishment of the 45p tax rate, by voting down sections of the Finance Bill, supporting amendments that would see it struck out. This resulted in the Government announcing that they will not go ahead with the scrapping of the 45p tax rate. However, this was not enough for Britain as even more pressure mounted on Liz Truss and her government, despite the pound and bond markets were slowly stabilising. Deciding to face this pressure, Liz Truss announced on 14th October that Kwasi Kwarteng was sacked, as the Chancellor of the Exchequer, and replaced by Jeremy Hunt. When it was announced that Truss would be addressing the nation on 14 October, the pound and bond markets faltered, which shows the lack of confidence in Truss from investors. Then, on 17 October, Jeremy Hunt scrapped almost all of the mini budget, in a bid to stabilise the financial markets. This included the axing of cuts to dividend rates, the scrapping of the planned rise of corporation tax and much more.

The Mini-Budget had a lot of repercussions, which included the value of the pound plummeting and financial markets faltering. However, as of 21 October, the  Mini-Budget has been mostly reversed by the new chancellor Jeremy Hunt. The pound and bond markets have started to stabilise; although, despite this, the Mini-Budget will have long lasting effects on the economy, which will take time.

It is also worth reflecting on the trickle-down economics of Truss. Whilst it is clearly an admirable aim to increase growth in the British economy, the idea of this being catalysed by a tax cut for the rich is widely derided. In fact empirical evidence proves that rich people save a greater proportion of income than the poor, therefore marginal propensity to save is higher amongst those with lower incomes. Meaning the government would have been more likely to achieve short term economic growth with a tax cut for lower earners. Furthermore, Margaret Thatcher and Ronald Reagan attempted to implement trickle-down economics in the 1980s, which ultimately failed to reach its goal, just as it has with Liz Truss.