Analysis: THE UK’S MINI-BUDGET AND THE FOLLOWING CRISIS

October 20th, 2022

Linh Truong

About "mini-budget"

Source: Wikipedia

On September 23th 2022, Kwasi Kwarteng proposed "The Growth Plan", also widely known as "mini-budget" to the House of Commons of the United Kingdom. The "mini-budget" contained a set of economic policies and huge tax cuts to reset the debate around growth. The series of tax cuts include the cutdown in income tax from 20% to 19%; the abolition of the 45% higher rate of income tax in England, Wales, and Northern Ireland; reversing a plan in March 2021 to increase corporation tax from 19% to 25% from April 2023; the reversal of the April 2022 increase in National Insurance; and the abolition of the proposed Health and Social Care Levy.

After the "mini-budget" was delivered to fight off a cost-living crisis, the value of the pound sterling against US dollars decreased sharply since world markets opposed the increased borrowing required. Right on the following trading day, the pound hit an all-time low against the US dollar. The British economy was facing 9% inflation so the unexpected tax cut policy received a widespread negative reaction. Some economists were also worried that the country would have to live on increased government borrowing to compensate for the tax cuts which are considered to be the largest in 50 years. The sequence of this event might be that the UK has to ask the International Monetary Fund for a financial bailout. Surprisingly, the IMF responded critically to the budget as they urged that it would raise inequality in the country and admonished the UK to re-evaluate the proposed tax cuts.

The Prime Minister Liz Truss and the Chancellor of the Exchequer Kwarteng didn't even bat an eyelid when the market upheaval went on and Members of Parliament including members of the Conservative Party called for a policy reversal; however, they stuck with the outlined proposals and believed in the future benefits of the mini-budget. Over weeks later, the outcome shook the position of Truss so she had to summon Kwarteng and asked for his resignation. Truss later appointed Jeremy Hunt to take over Kwarteng's position. Subsequently, Hunt reversed almost all of the tax cuts policy. His decision happened to make the market positive again.

Effects

Source: The Guardian

• The pound nosedived to 1.03 against the US dollar, which was recorded low, after the announcement of Kwarteng to continue expanding his £45 billion package of tax cuts. The pound-dollar was about 1.12 on the mini-budget day and hit its low on Monday before recuperating to near 1.12 on Friday.

• The Bank of England set off an emergency £65 billion bond-buying program to curb the financial crisis triggered by the mini-budget.

• The yields on 10-year gilts surged from 3.5% to 4.3% after the introduction of Kwarteng's growth plan. Then, with the intervention of the Bank of England, the bonds' yields decreased to 4.05%.

• The British Retail Consortium announced that food price inflation soared to 10.6% compared to surprisingly high rates of 9.3% last month.

• The FTSE 100 fell by about 232 points.

• Labour held a 33-point lead over the Conservatives due to a poll on YouGov, which was considered to be the largest poll since the late 1990s.

• On Thursday, jittery lenders had withdrawn 1,621 mortgage products from the market. Witnessing the crisis resulting from the wrong policy, lenders were uncertain about the prospect of their money and lost faith in the government's plan.

Why did the "mini-budget" hurt the UK's economy?

• The most worrisome problem that the UK had to face was the plunge in the value of the pound against the US dollar. As the value of the pound decreased, the country would have to pay a greater price for importation.

• Investors were nervous about losing their money so they sold their shares and ran away from the market. Accordingly, the prices of shares lost many points which affected the companies' activities.

• The pension funds were at risk of being insolvent since the funds were used up to supply other fees from tax cuts.

• The mini-budget triggered a surge in bond yields. Yields rise when lenders are not willing to let issuers borrow their money. In this case, the issuer is the UK government, which just made a big wrong step causing a crisis in the national economy. Investors find it risky to sell their bonds in the market and the price of gilts will undoubtedly plummet. For this reason, yields will subsequently rise. The rise of yields means higher debts that the government has to face which is mounting the severity of the crisis.

• Food is the most important necessity for residents at any time so the food price inflation amid the crisis is a horror for the whole country.

• Lenders of mortgages lost trust in the government's plan and were afraid of losing their money so they withdrew their mortgages. This situation would shorten the money supply of the government.

• The policy was critically reacted to since it strengthened inequality in the country. As the government cut taxes for businesses, the first ones who directly benefited from this were the employers or the rich. The employees or the lower class still suffered from financial issues. When the rich benefited more but the lower class received nothing, the Gini coefficient (the measure of income inequality) became higher.

Why was the "mini-budget" unsuitable at this time?

At that time, the national money supply was deficient, and the inflation along with the economic downturn caused businesses and residents to suffer from financial problems. If businesses could not invest in their products, the market could not develop. With this in mind, Kwarteng proposed the mini-budget. However, the outcome didn't turn out in the way he expected.

The national budget was deprived but the government continued to spend more money. Subsequently, the government had to borrow money and used that money source to spend. Commonly, when we have a small pocket of money, we have to cut down on spending but the UK government continued to spend. And to fill up the spending, the government had to print more cash while the immanent value of currency didn't increase. Of this fact, the value of the pound against the US dollar decreased.

The tax cuts policy included cutting large governmental loans. The government spent a large amount of money but the money supply from loans was cut so they had to print more money.