Emergency budget announcement: expert reaction to new UK chancellor's attempt to calm financial markets -Targeted policies needed

18th October 2022

Morten Ravn, Professor of Economics at University College London, UCL.

This was an inescapable U-turn. The September mini-budget brought market turmoil because it caused an unsolvable policy inconsistency with the Bank of England. This inconsistency was seriously threatening the economic and financial stability of the UK economy.

The unfinanced tax cuts announced in the mini-budget immediately affected government bond prices and the Sterling exchange rate. Declining long-term government bond prices put pressure on large UK pension funds, which forced the Bank of England to support the gilt market by buying long-term government debt.

The Bank of England has therefore, on the one hand, had to increase short-term rates to reduce inflationary pressures on the UK economy while, on the other, support long-term bond markets with its recent purchase programme. Such policy inconsistency can only persist for a short time before it risks a speculative attack on the gilt market and further downward pressure on the sterling.

The increase in inflation in the UK hurts lower income households more than those that are better off because these people spend a greater portion of their incomes on goods and services with rapidly rising costs such as energy. Therefore, there is a need for targeted policies offering protection for the poorest parts of society - something the government should bear in mind when designing a replacement energy price support package after April.

So will the U-turn work? Markets appear to have been stabilised so far. What is still missing in an Office of Budgetary Responsibility evaluation of the fiscal framework and details about the financing of the government deficit. It is important that both of these issues are resolved quickly. This might involve very difficult spending cuts.

It is extremely unfortunate that precious time has been lost over the last few weeks that could have been used for designing these cuts in the least harmful way possible. It is also extremely unfortunate that this episode has seriously undermined the credibility of the UK's monetary-fiscal framework. Confidence must be restored as fast as possible. It is equally important to rethink the energy price cap and replace it with targeted policies and better incentives in terms of energy efficiency.

Note
This is part of an article from the conversation web site.
See it in full HERE