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    Lessons From Liz Truss’s Handling of U.K. Inflation

    The sharp policy U-turn by Liz Truss, Britain’s prime minister, reveals the perils of taking the wrong path in the fight against scalding inflation.Government leaders in the West are struggling with rising inflation, slowing growth, and anxious electorates worried about winter and high energy bills. But Liz Truss, Britain’s prime minister, is the only one who devised an economic plan that unnerved financial markets, drew the ire of global leaders and the public and undermined her political standing.On Friday, battered by savage criticism, she retreated. Ms. Truss fired her top finance official, Kwasi Kwarteng, for creating precisely the package of unfunded tax cuts, billion-dollar spending programs and deregulation that she had asked for.She reinstated a scheduled increase in corporate taxes to 25 percent from 19 percent, a rise she had previously opposed. That announcement came on top of backtracking last week on her proposal to eliminate the top 45 percent income tax on the highest earners. The prime minister, in office a little over five weeks, also promised that spending would grow less rapidly than proposed, although no specifics were offered.The drama is still playing out, and it’s unclear if the Truss government will survive.In the United States, President Biden, while waging his own political battles over gas prices and inflation, has not proposed anything like the kind of policies that Ms. Truss’s government attempted, nor have any other leaders in Europe.Still, for European governments whose economies are suffering greatly from shocks and energy price surges caused by Russia’s war in Ukraine, there are timely lessons from the debacle playing out in London.One of the strongest was delivered early on by the International Monetary Fund: Don’t undermine your own central bankers. The I.M.F., which usually reserves such scoldings for developing nations, on Thursday doubled down on its message. “Don’t prolong the pain,” Kristalina Georgieva, the managing director, admonished.How to blunt the impact of inflation on the most vulnerable without further stoking inflation is the dilemma that every government is confronting.The Bank of England in London has aggressively tried to slow the sharp rise in prices by slowing the British economy.Alberto Pezzali/Associated Press“That is the question of the hour,” said Eswar Prasad, an economist at Cornell University who was attending the annual meetings of the World Bank and I.M.F. in Washington this week.Tension between the fiscal spending policies proposed by a government and the monetary policies controlled by central banks is not unusual. At the moment, though, central bankers are engaged in delicate policy maneuvers in the fight against a level of inflation not seen in decades. With the rate in Britain nearing 10 percent, the Bank of England has moved aggressively to slow down climbing prices through a series of interest rate increases aimed at crimping consumer and business spending.Any expansion of government spending is going to interfere with that aim to some degree, but Ms. Truss’s plan was far too big and too ill defined, Mr. Prasad said.“Measures to help households hit hard by energy increases, by themselves, would not have created that much of a stir,” he said. Many other countries have proposed exactly that. And the European Union has proposed a windfall tax on energy profits to help finance those subsidies.Ms. Truss, instead of coming up with a way to pay for energy assistance, pushed to eliminate a corporate tax increase and cut income taxes for the wealthiest segment of the population. The result was a reduction in government revenue and a ballooning of Britain’s debt.“Overall, the package did not have much clarity in terms of how it would support the economy in the short run without raising inflation,” Mr. Prasad said.By contrast, Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, cited the way governments and central banks worked in tandem when the pandemic struck in 2020 to keep economies from collapsing, issuing vast amounts of public debt.“Central banks printed every single dollar, euro and pound that governments spent” to support households and businesses because of the Covid crisis, Mr. Vistesen said. But now the circumstances have changed, and inflation is setting economies aflame.The actions of the Federal Reserve in the United States illustrate the switch central banks have made: In the harrowing early weeks of the global outbreak of the coronavirus, the Fed embarked on an extraordinary program to stimulate the economy and stabilize markets. This year, the Fed has been swiftly raising interest rates in a bid to slow growth.Both the United States and eurozone countries have somewhat more wiggle room than Britain, because the dollar and the euro are much more widely used around the world as currencies held in reserve than the British pound.Kwasi Kwarteng, Britain’s former chancellor of the Exchequer, left 11 Downing Street after Ms. Truss fired him on Friday.Kirsty Wigglesworth/Associated PressEven so, European governments can help households and businesses get through an energy crisis, Mr. Vistesen said, but they can’t embark on an open-ended spending spree.They also need to take account of what is happening in other economies. The richest countries that make up the Group of 7 are essentially part of the same “monetary and fiscal convoy,” said Will Hutton, president of the Academy of Social Sciences. By championing a Thatcher-era blend of steep tax cuts and deregulation, he said, the Truss government strayed too far from the rest of the flotilla and the economic mainstream.The adherence to 1980s-era trickle-down verities also revealed the risks of sticking with outdated policies in the face of changing circumstances, said Diane Coyle, a ​​public policy professor at the University of Cambridge.“The situation in 1979 was very different,” Ms. Coyle said. “There were sclerotic high taxes and an overregulated economy, but not anymore.” Today, taxes in Britain are lower, and the economy is less regulated than the average member of the Organization for Economic Cooperation and Development, a club of 38 major economies.“The character of the economy has changed,” she said. “Public investment in research and skills are more important.”In that sense, what was missing from Ms. Truss’s economic plan was as important as what was included. And what Britain is lacking, said Mariana Mazzucato, an economist at University College London, is a visionary public investment program like the trillion-dollar climate and digitalization plans adopted by the European Union or the climate and infrastructure program in the United States.A rate of Inflation nearing 10 percent in Britain has affected the price of groceries and how people spend their money.Alex Ingram for The New York Times“If you don’t have a growth plan, an industrial strategy innovation policy,” Ms. Mazzucato said, “then your economy won’t expand.”Both Ms. Mazzucato and Ms. Coyle emphasized that Britain had some specific economic handicaps that predated the Truss administration, including the 2016 vote to exit the European Union, a stubborn lack of productivity, anemic business investment, and lagging research and development.Still, Ms. Coyle offered some advice that referred pointedly to Ms. Truss. “I think the main lesson is: Don’t shoot yourself in the foot.” More

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    U.K. Government Plans an Update to Its Tax and Spending Agenda

    After an earlier announcement sent markets into a tailspin, the prime minister and the chancellor are under pressure to restore fiscal credibility.After days of confusion, Britain’s government said on Monday that the date for its next fiscal policy announcement would be moved up nearly a month and that it would provide, at the same time, a much-anticipated independent assessment of the policies’ impact on the nation’s economy and public finances.The chancellor of the Exchequer, Kwasi Kwarteng, said he would publish his “medium-term fiscal plan” on Oct. 31, which would show how the government, under the new prime minister, Liz Truss, would bring down debt levels despite large spending plans and tax cuts that would be funded by borrowing.New economic and fiscal forecasts from the Office for Budget Responsibility, a government watchdog, are to be published the same day.The move is aimed to reassure financial markets and the public of the new government’s fiscal credibility. Its first major economic announcement, a speech by Mr. Kwarteng on Sept. 23, was dominated by unfunded tax cuts at a time of high inflation, and it quickly sent markets into a tailspin: The British pound hit a record low against the dollar, and turmoil in the bond market led to higher mortgage rates and intervention from the Bank of England to protect pension funds.Since then, the government has canceled its plan to abolish the top income tax rate for the highest earners — the most surprising tax-cutting measure announced last month — and tried to restore its fiscal credibility, while maintaining its commitment to an agenda of using tax cuts and deregulation to speed economic growth.Rising Inflation in BritainInflation Slows Slightly: Consumer prices are still rising at about the fastest pace in 40 years, despite a small drop to 9.9 percent in August.Interest Rates: On Sept. 22, the Bank of England raised its key rate by another half a percentage point, to 2.25 percent, as it tries to keep high inflation from becoming embedded in the nation’s economy.Truss’s Experiment Stumbles: Prime Minister Liz Truss says a mix of tax cuts and deregulation is needed to jump-start Britain’s sluggish economy. Investors, economists and some in her own party disagree.Mortgage Market: The uptick in interest rates roiled Britain’s mortgage market, leaving many homeowners calculating their potential future mortgage payments with alarm.Part of this rehabilitation effort included a promise to publish a more detailed fiscal plan focused on reducing debt and provide an independent analysis by the Office for Budget Responsibility. But the date was set for Nov. 23 — too long to wait, said fellow Conservative Party members, opposition lawmakers and investors.Liz Truss, the prime minister, with Mr. Kwarteng visiting a construction site last week. Pool photo by Stefan RousseauLast week, it was widely reported that the date would be moved forward, and Mr. Kwarteng denied this. On Monday, he confirmed that the announcement would indeed arrive on Oct. 31.Two weeks ago, in the immediate aftermath of Mr. Kwarteng’s policy speech, the pound plummeted to $1.035 and speculation grew that it could reach parity with the dollar. The cancellation of the top tax rate cut, which the government argued had become a distraction from its overall growth plan, helped the currency rebound a bit.But that recovery has stalled. On Monday, the pound was trading around $1.10 amid skepticism that the government’s plan would expand the economy as promised, and that instead large public spending cuts would be necessary.Fitch Ratings said on Monday that it expected the British economy to contract 1 percent next year, after “extreme volatility” in British financial markets and the prospect of “sharply higher” interest rates. Last month, it forecast a 0.2 percent decline for next year.“Rising funding costs, tighter financing conditions, including for mortgage borrowers, and increased uncertainty will outweigh the impact of looser fiscal policy” next year, analysts at the ratings agency wrote. They expect Britain’s economy to enter a recession in this quarter. The agency has already changed its ratings outlook for Britain to negative.That was just one of many rebukes of the government’s plans. For example, the International Monetary Fund encouraged the government to re-evaluate the tax cuts, which it said would increase inequality.But Ms. Truss, seeking to reverse years of sluggish growth and weak productivity, has been clear that she wants to run the economy differently than her predecessors. One early decision was to fire the top civil servant in the Treasury, Tom Scholar, a move that rattled some analysts. On Monday, the government announced his successor, James Bowler, who will transfer from the international trade department but spent two decades at the Treasury previously.Even as the government makes conciliatory moves, there are signs of distress in financial markets. On Monday, the Bank of England said it would expand its intervention in the bond market. The bank will increase the size of the daily auctions in a bond-buying program that was set up to support pensions funds, after tumult in this market threatened Britain’s financial stability.Over the last eight trading days, the bank bought only about 5 billion pounds of long-dated government bonds in total, despite setting a limit of £5 billion a day. With markets wondering what will happen when the bond-buying operation ends on Friday, the central bank announced that it would expand its support. As well as increasing the auction sizes, it will set up a new collateral facility to try to ease liquidity problems faced by the pension funds. That facility will continue beyond this week.The announcement appeared to do little to ease the markets. On Monday, Britain’s bond prices kept falling, while the yield on 30-year bonds rose to 4.72 percent, once again approaching highs seen during the worst of the bond rout after the last fiscal statement.The financial district in London. The new government’s first major economic announcement, on Sept. 23, quickly sent markets into a tailspin.Alex Ingram for The New York Times More

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    Economists Nervously Eye the Bank of England’s Market Rescue

    The Bank of England stepped in to save a critical market this week. Economists say it was necessary but also worry about the precedent.When the Bank of England announced last week that it would buy bonds in unlimited quantities in an effort to stabilize the market for U.K. government debt, economists agreed it was probably a necessary move to prevent a cataclysmic financial crisis.They also worried it could set a dangerous precedent.Central banks defend the financial stability of the nations in which they operate. In an era of highly leveraged and deeply interconnected markets, that means that they sometimes have to buy bonds or backstop lending to prevent a problem in one area from spiraling into a crisis that threatens the entire financial system.But that backstop role also means that if a government does something to generate a major shock, politicians can be fairly confident that the local central bank will step in to stem the fallout.Some economists say that is essentially what happened in the United Kingdom. Liz Truss, the new prime minister, proposed a huge package of tax cuts and spending during a period of already high inflation, when standard economic theory suggests governments should do the opposite. Markets reacted forcefully: Yields on long-term government debt shot up, and the value of the British pound fell sharply relative to the dollar and other major currencies.The Bank of England announced that it would buy long-term government debt “on whatever scale is necessary” to prevent a full-blown financial crisis. The move was particularly striking because the bank had been poised to begin selling its bond holdings — a plan that is now postponed — and has been raising interest rates in a bid to bring down inflation.Economists broadly agreed that the bank’s decision was the right one. The rapid rise in interest rates sent shock waves through financial markets and upended a typically sleepy corner of the pension fund industry, which, left unaddressed, could have carried severe consequences for millions of workers and retirees, destabilizing the country’s entire financial system.“You saw very substantial market dislocation,” said Lawrence H. Summers, a former U.S. Treasury Secretary who is now at Harvard. “It’s a recognized role of central banks to respond to that.”To some economists, that was exactly the problem: By shielding the U.K. government from the full consequences of its actions — both preventing citizens from feeling the painful aftereffects and keeping government borrowing costs from shooting higher — the policy demonstrated that central bankers stand ready to clean up messy fallout. That could make it easier for elected leaders around the world to take similar risks in the future.Those concerns eased somewhat on Monday when Ms. Truss partly backed down, reversing plans to abolish the top income tax rate of 45 percent on high earners.But she appears poised to go forward with the rest of her proposed tax cuts and spending programs, putting the Bank of England in a delicate spot.Rising Inflation in BritainInflation Slows Slightly: Consumer prices are still rising at about the fastest pace in 40 years, despite a small drop to 9.9 percent in August.Interest Rates: On Sept. 22, the Bank of England raised its key rate by another half a percentage point, to 2.25 percent, as it tries to keep high inflation from becoming embedded in the nation’s economy.Mortgage Market: The uptick in interest rates roiled Britain’s mortgage market, leaving many homeowners calculating their potential future mortgage payments with alarm.Investor Worries: The financial markets have been grumbling with unease about Britain’s economic outlook. The government plan to freeze energy bills and cut taxes is not easing concerns.The “partial U-turn” from Ms. Truss “still leaves the Bank of England with a set of near-impossible choices,” analysts at Evercore ISI wrote in a note to clients. “The only way to alleviate this is for the government to take much bigger steps to restore credibility — but there is little sign this is imminent.”There’s a reason that the interplay between monetary policy and politics in the United Kingdom is garnering so much attention. Central banks have for decades closely guarded their independence from politics. They set their policies to either stoke the economy or to slow it down based on what was necessary to achieve their goals — in most cases, low and stable inflation — free from the control of elected officials.The logic behind that insulation is simple. If central bankers had to listen to politicians, they might let price increases get out of control in exchange for faster short-term growth that would help the party in power.Now, that independence is being tested, and not just in the United Kingdom. Central banks around the world are raising interest rates to try to fight inflation, resulting in slower growth and making it harder for governments to borrow and spend. That is likely to lead to tension — if not outright conflict — between central bankers and elected leaders.It is already beginning. A United Nations agency on Monday warned that the Federal Reserve risked a global recession and significant harm in developing countries, for instance. But the United Kingdom’s example is stark because the elected government is carrying out policy that works against what the nation’s central bank is trying to achieve.“One always worries that actions like these can affect incentives going forward,” said Karen Dynan, a Harvard economist who served as a top official in the Treasury Department under President Obama. “It’s basic economics: People respond to incentives, and fiscal policymakers are people.”Part of the issue is that it is hard for central bankers to single-mindedly focus on controlling inflation in an era when financial markets are fragile and susceptible to disruption — including disruptions caused by elected governments.Before 2008, the Fed had never used mass long-term bond purchases to calm markets in its modern era. It has now used them twice in the span of 12 years. In addition to last week’s moves, the Bank of England also turned to mass bond purchases to calm markets in 2020.Bank of England officials have stressed that the policies they announced last week are a temporary response to an immediate crisis. The bank plans to buy long-dated bonds for less than two weeks and says it will not hold them longer than necessary. The Treasury, not the bank, will be responsible for any financial losses. The bank said it remained committed to fighting inflation, and some economists have speculated that it could raise rates even more aggressively in light of the government’s growth-stoking policies.If the bank is able to hold to that plan, it could mitigate economists’ concerns about the longer-run risks of the program. If interest rates rise again and it gets more expensive for the government to borrow, Ms. Truss will still need to grapple with the costs of her proposed programs, just without facing an imminent financial crisis.But some economists warn that the Bank of England may find the situation harder to extricate itself from than it hopes. It may turn out that the bank needs to keep buying bonds longer than expected, or that it cannot sell them without threatening another crisis. That could have the unintentional side effect of giving the British government a helping hand — and it could demonstrate that it is hard for a big central bank to remove support from its economy when the elected government wants to do the opposite.Liz Truss, Britain’s prime minister, will still need to grapple with the costs of her proposed programs, but she won’t be facing an imminent financial crisis because of the Bank of England’s actions.Alberto Pezzali/Associated PressMs. Truss’s policies — particularly before her partial reversal on Monday — would work directly against the bank’s efforts to cool growth, stoking demand through lower taxes and increased spending. The rapid rise in bond yields last week suggested that investors expected inflation to rise even further.Under ordinary circumstances, these conditions would lead the Bank of England to do even more to bring down the inflation it had already been fighting, raising interest rates more quickly or selling more of its bond holdings. Some analysts early last week expected the bank to announce an emergency rate increase. Instead, the brewing financial crisis forced the bank to do, in effect, the opposite, lowering borrowing costs by buying bonds.While lowering rates and stoking the economy was not the point — just a side effect — some economists warn that those actions risk setting a dangerous precedent in which central banks can only tighten policy to control inflation if their national governments cooperate and do not roil markets in a way that threatens financial stability. That situation puts politicians more in the driver’s seat when it comes to making economic policy.Guillaume Plantin, a French economist who has studied the interplay between central banks and governments, likened the dynamic to a game of chicken: To avoid a financial crisis, either Ms. Truss had to abandon her tax-cut plans, or the Bank of England had to set aside, at least temporarily, its efforts to raise borrowing costs. The result: “The Bank of England had to chicken out,” he said.Policymakers have known for decades that when the government steps in to rescue private companies or individuals, it can encourage them to repeat the same risky behavior in the future, a situation known as “moral hazard.” But in the private sector, there are steps governments can take to offset those risks — regulating banks to reduce the risk of collapse, for example, or wiping out shareholders if the government does need to step in to help.It is less clear what monetary policymakers can do to prevent the government itself from taking advantage of the safety net a central bank provides.“There is a moral hazard here: You are protecting some people from the full consequences of their actions,” said Donald Kohn, a former Fed vice chair and a former member of the Bank of England’s Financial Policy Committee, who agreed that it is necessary to intervene to prevent market dysfunction. “If you think about the entities that benefited from this, one was the chancellor of the Exchequer, the government.”Some forecasters have warned that other central banks might have to pull back on their own efforts to fight inflation to avoid destabilizing financial markets. Some investors are speculating that the Fed will have to end its policy of shrinking government bond holdings early or risk stirring market turmoil, for instance.Not all of those scenarios would necessarily raise the same concerns. In the United States, the Biden administration and the Fed are both focused on fighting inflation, so any reversal by the central bank would probably not look like bowing to pressure from the elected government.Still, the common thread is that financial stability issues could become a hurdle in the fight against inflation — especially where governments do not decide to go along with the push to rein in prices. And how worrying the British precedent proves will depend on whether the Bank of England is capable of backing away from bond buying quickly.“Is this just an exigent moment that they needed to respond to, or does it give the fiscal authority room to be irresponsible?” said Paul McCulley, an economist and the former managing director at the investment firm PIMCO. “The question is who blinks.”Joe Rennison More

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    Liz Truss’ Woes Multiply After Media Blitz

    In a round of interviews, the prime minister showed little sympathy for the pain that high interest rates could inflict on mortgage holders, critics said.LONDON — For Prime Minister Liz Truss, it was a chance to steady the waters after days of turmoil in the financial markets over her new fiscal plan: eight rapid-fire interviews with local BBC radio stations from Leeds to Nottingham.By the time Ms. Truss signed off from the last one on Thursday morning, her political woes had multiplied, leaving her new government in a state of disarray almost without precedent in recent British politics.She was, critics said, robotic in defending a tax-cut plan that had been eviscerated by the markets, and showed little sympathy for the pain that high interest rates could inflict on mortgage holders. One host described her as a “reverse Robin Hood.” A listener on another station asked, “Are you ashamed of what you’ve done?”Barely three weeks into her job, Ms. Truss has suffered a dizzying loss of public support. Her Conservative Party now trails the opposition Labour Party by 33 percentage points, according to a new poll by the market research firm YouGov. That is the largest Labour lead since Tony Blair’s early days as prime minister in 1998, and the kind of gap that usually results in a landslide election defeat.Her plunging poll numbers have badly damaged Ms. Truss’s standing in her party, which is gathering on Sunday in Birmingham for what promises to be an anxious annual conference. Some speak openly of the party ousting her before the next election, though the mechanics for doing that remain complicated.“This is by far the biggest and swiftest hit to a party’s opinion poll rating that British politics has ever seen,” said Tim Bale, a professor of politics at Queen Mary University of London. “For Tory MPs, this is like realizing on your wedding night that you’ve made a truly terrible mistake.”Matthew Goodwin, a politics professor at Kent University and an expert on the Tory Party, said, “I can’t think in my lifetime of any British prime minister who has mismanaged her first few weeks in office like Liz Truss.”What makes Ms. Truss’s predicament so difficult is that none of the escape hatches are appealing. Reversing some of her tax cuts — particularly the one for the top income bracket of people earning more than 150,000 pounds, or about $164,000, a year — would mollify the markets and probably some voters.Tax cuts announced last week by Kwasi Kwarteng, Britain’s chancellor of the Exchequer, threw the markets into turmoil.Clodagh Kilcoyne/ReutersBut it would be a heavy psychological blow for a leader who ran her campaign, and has built her government, on the conviction that tax cuts and supply-side policies will reignite growth. Giving that up, Professor Bale said, would vitiate the ideological rationale of her government and potentially turn her into a lame-duck leader until the next election, which she will have to call by early 2025.Sticking to her guns, which has been Ms. Truss’s response so far, leaves open the chance that Britain’s economy will pick up by the time she faces voters. But the stubborn threat of inflation all but guarantees that the Bank of England, Britain’s central bank, will keep raising interest rates. That will hurt people who need to refinance home mortgages and likely throw the broader economy into a recession.More on Politics in BritainPrime Minister Liz Truss was chosen by a divided British Conservative Party to lead a country facing the gravest economic crisis in a generation.A Domestic Push: After a period of mourning for the death of Queen Elizabeth II, the new government led by Ms. Truss began to work in earnest, announcing several initiatives to address Britain’s economic and social problems.A Turn Toward Thatcherism: Ms. Truss bet on a heavy dose of tax cuts, deregulation and free-market economics to reignite growth. The negative reaction from financial markets underscored the extent of the gamble.Seizing the Moment: Accusing Ms. Truss of losing control of Britain’s economy, the leader of the opposition Labour Party, Keir Starmer, staked his claim as the guardian of sound fiscal policy.Energy Policies: The British government said it would freeze electric and gas bills for households and cut energy costs for companies in an effort to mitigate the effects of Russia’s restriction of gas supplies to Europe.When she was asked by BBC Radio Stoke about her fiscal plan’s impact on the housing market, Ms. Truss paused before saying, “Interest rates are a matter for the independent Bank of England.” She added that “interest rates have been rising around the world” and blamed much of the crisis on Russia’s war in Ukraine.For the last few days, the bank has actually helped Ms. Truss by intervening in the market to buy British government bonds. That brought down interest rates and strengthened the pound, which had tumbled to its lowest level against the dollar since 1985. On Friday, the pound traded up to $1.11.But the intervention, which was driven by fears of the damage done to British pension funds by the turbulent market, has put the Bank of England in an awkward position, economists said. It runs counter to the bank’s monetary policy of raising interest rates to cool inflationary pressures.“The bank has had to reverse course on its objectives practically overnight,” said Eswar Prasad, a professor of economics at Cornell University. “It looks like the bank is being forced to clean up the adverse consequences of the U.K. Treasury’s actions.”“This could have some longer-term implications for the bank’s independence, credibility, and effectiveness,” Professor Prasad continued. “That really hampers it in its ability to fulfill its objectives.”Once the Bank of England completes its bond-buying program on Oct. 14, economists said they expected it to revert to its tighter monetary policy, which would suggest another increase in interest rates at its November meeting. The only government action that could forestall, or even moderate a sharp spike in rates, economists said, would be if the government reversed one of more of its tax cuts.“Absent that U-turn, the bank is going to have to raise interest rates a lot,” said Adam S. Posen, who served on the Bank of England’s monetary policy committee. He said the bank needed to curb both the inflation from an expansionary fiscal budget and the additional inflation caused by a devalued pound.Once the Bank of England completes its bond buying program, economists expect it to revert to its tighter monetary policy by possibly raising interest rates at its November meeting.Hannah Mckay/ReutersBeyond the tug-of-war between fiscal and monetary policy, critics say Ms. Truss faces a more elemental problem: her chancellor of the Exchequer, Kwasi Kwarteng, has lost the faith of the markets in his economic stewardship.That is partly because when Mr. Kwarteng announced the tax cuts last week, he did not submit the package to the scrutiny that a government budget normally receives. That fed fears that the tax cuts were “unfunded,” meaning that they would not be matched with cuts in spending and so would require massive borrowing.On Friday, Mr. Kwarteng and Ms. Truss met at Downing Street with officials from the government’s forecasting agency, the Office of Budget Responsibility — a move designed to signal they now welcomed the scrutiny. The office will submit its projections for the cost of the fiscal program and its effect on Britain’s growth on Oct. 7, but the government will not publish the numbers until Nov. 23.For Ms. Truss, the political fallout from her program’s botched rollout has been profound. Political analysts point out that she won the support of only a third of Conservative Party lawmakers in the first stage of the leadership contest. Now, the collapsing polls have left the lawmakers angry, fearful, and divided.Unless the trends are reversed, many of the party’s members in Parliament will be swept out of their seats in the next election, particularly in the “red wall” districts of the Midlands and the North, where Ms. Truss’s predecessor, Boris Johnson, lured traditional Labour voters to switch to the Tories with his promise to “Get Brexit done.”That realignment of British politics is in jeopardy. Professor Goodwin, of the University of Kent, said these voters did not want Ms. Truss’s low-tax, neoliberal economic policies. Adding to the alienation, he said, she was determined to relax immigration laws, another core issue for working-class voters.“We’re seeing the complete implosion of the Conservative vote,” Professor Goodwin said. “They’re losing middle-class voters who are alienated by Brexit, and working-class voters who are alienated by their economic policy.”For all the hand-wringing, it is not immediately clear what the Tories can do about it. Three months after evicting Mr. Johnson from Downing Street, few people want to go through with another protracted, divisive leadership contest.Professor Bale said another option would be for the party to settle on a consensus alternative to Ms. Truss and then pressure her to step down, so the new leader could be crowned without any delay. The problem with this scenario, he said, is a lack of obvious candidates to step into the role of the party’s savior. More

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    Britain’s Gamble on Tax Cuts has Economists Warning of Past Mistakes

    The International Monetary Fund is just one of the many voices that have criticized a plan to cut rates for high earners.WASHINGTON — A stunning rebuke from the International Monetary Fund this week underscored one of the biggest risks of the new British government’s plan to slash taxes on high earners: It could exacerbate rapid inflation and destabilize markets at a precarious economic moment.The alarm from economists, central bankers, investors and top U.S. officials centered on the likelihood that the tax cuts could stoke consumer demand by giving people more money to spend, pushing crushingly high prices even higher. That would put the British government in direct conflict with aggressive efforts of the central banks around the globe — and in the United Kingdom — that are raising interest rates in a bid to bring inflation under control.Many economists say British officials are also ignoring the lessons of the most recent bout of tax cuts — those engineered in the United States by former President Donald J. Trump. Empirical research on the early results of those cuts suggests that they mostly helped the economy by temporarily increasing consumer demand, an outcome that could prove particularly damaging in the high-inflation environment that Britain and much of the world are experiencing.Liz Truss, Britain’s new prime minister, has staked her fledgling government on a oversize, once-in-a-generation package of tax cuts and deregulation meant to energize the economy. It includes a cut in rates for the country’s lowest income tax bracket — and, in what was a surprise move, a five-percentage-point cut in the country’s top income tax rate, which applies to those earning more than 150,000 pounds, or about $164,000, a year.The International Monetary Fund responded to those proposals with the sort of pointed criticism it typically reserves for an emerging-market economy, not for the economy of one of the wealthiest nations in the world.“Given elevated inflation pressures in many countries, including the U.K., we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy,” the I.M.F. said in a news release on Tuesday.The statement noted that the tax cuts would most likely increase economic inequality, and it urged the British government to “provide support that is more targeted and re-evaluate the tax measures, especially those that benefit high income earners.”More on Politics in BritainPrime Minister Liz Truss was chosen by a divided British Conservative Party to lead a country facing the gravest economic crisis in a generation.A Domestic Push: After a period of mourning for the death of Queen Elizabeth II, the new government led by Ms. Truss began to work in earnest, announcing several initiatives to address Britain’s economic and social problems.A Turn Toward Thatcherism: Ms. Truss bet on a heavy dose of tax cuts, deregulation and free-market economics to reignite growth. The negative reaction from financial markets underscored the extent of the gamble.Seizing the Moment: Accusing Ms. Truss of losing control of Britain’s economy, the leader of the opposition Labour Party, Keir Starmer, staked his claim as the guardian of sound fiscal policy.Energy Policies: The British government said it would freeze electric and gas bills for households and cut energy costs for companies in an effort to mitigate the effects of Russia’s restriction of gas supplies to Europe.Investors have also recoiled from the plan, sending British bond yields soaring — forcing the Bank of England to intervene to stabilize them — and causing the value of the pound to plummet.Ms. Truss is not the first conservative politician in recent years to come into office promising to slash taxes. Mr. Trump also campaigned on — and ultimately delivered — “massive tax cuts” in 2017, a package that only Republican lawmakers backed. Decades ago, President Ronald Reagan and Prime Minister Margaret Thatcher of Britain both pursued tax-cutting agendas that cemented their legacies in office.Ms. Truss has been cheered on by conservative champions of supply-side economics in the United States, including many of the chief backers of Mr. Trump’s tax cuts. Stephen Moore, who served as an outside economic adviser to the former president, praised Ms. Truss for her willingness “to challenge the reigning orthodoxy by sharply cutting taxes to boost growth,” calling the package “a gutsy and sound policy decision.”“By far the most important change is the reduction in the top income tax rate from 45 percent to 40 percent,” Mr. Moore wrote. “This will bring jobs, capital and businesses back to the U.K.”A host of critics, though, have lined up to denounce the tax package, warning it will provoke economic war with the Bank of England and risk a damaging combination of economic contraction and soaring prices, which could in turn hurt the global recovery.The impact of previous tax cuts, including those signed into law by Mr. Trump in 2017, provides fodder for those critiques.Much as Ms. Truss has proposed to do, Mr. Trump reduced tax rates for income earners across the spectrum, including those in the highest bracket. He also cut a variety of business tax rates — a contrast with the British plan, which cancels a planned increase in corporate taxes. Mr. Trump said his full package of cuts would jump-start economic activity by encouraging businesses to invest, hire and raise wages.Yet initial evidence, which includes studies from I.M.F. economists, suggests Mr. Trump’s cuts did not deliver the steep gains in investment and productivity that conservatives had promised. If such gains came to pass in Britain, they could help counter inflation there.Instead, the cuts increased consumer spending, an outcome that helped temporarily expand growth in the United States, the I.M.F. found, but which could be dangerous in a high-inflation environment.“The record through 2019 from the Trump tax cuts is not encouraging for the U.K.,” said William G. Gale, a co-director of the Urban-Brookings Tax Policy Center in Washington.Last year, Mr. Gale and a colleague, Claire Haldeman, published a study on the effects of Mr. Trump’s tax cuts up until the start of the pandemic recession. They looked for supply-side effects — whether the cuts increased investment incentives and other means of stimulating sustained economic growth — and found little evidence of such results.Instead, they found that the cuts did little to promote job growth or investment outside the oil and gas sector, which is highly correlated with the global price of fossil fuels. And they found that the cuts significantly reduced federal tax revenues, contrary to Republicans’ promises that the cuts would pay for themselves by inciting additional economic growth.Broader research suggests that Ms. Truss’s cuts for top earners are unlikely to drive significant gains in economic growth. In a recent study of decades of tax changes, Owen Zidar, an economist at Princeton, found that cuts for the top 10 percent of earners did little to prompt job gains.The hope that cuts in Britain’s top rate will supercharge the economy, Mr. Zidar said in an interview, “is completely at odds with the empirical record of the United States since 1950.”Mr. Gale, Mr. Zidar and other economists joined the I.M.F. in noting a particular challenge for the British tax cuts: the likelihood that they will be offset by interest rate increases from the Bank of England, as it seeks to bring down price growth.Other rounds of tax cuts, like those under Mr. Reagan, helped to increase growth by working in tandem with interest rate cuts taken by the Federal Reserve, according to economists who specialize in tax policy. In Britain’s case, the opposite appears to be true: The Bank of England has already been raising rates, and it appears ready to push them even higher to offset the effects of Ms. Truss’s policies. Those rate increases would negate a major goal of the tax cuts — to make it cheaper for companies to invest — by raising the costs of borrowing across the economy.Economists say faster rate increases also heighten the risk of recession in Britain.Supporters of the British tax cuts are already accusing the central bank of crippling them — much as Mr. Trump accused the Fed of undermining his tax cuts when it raised interest rates repeatedly after they were enacted.“It hasn’t helped that the Bank of England has launched a public campaign to sabotage the Truss agenda,” Mr. Moore wrote this week, echoing comments he made about the Fed in 2019.The actions of the British government could reverberate far beyond that country’s borders given the flows of international trade and the potential for a far-flung financial crisis. In recent days, President Biden has grown more concerned with the situation in Britain. On Wednesday, he met with members of his economic team to discuss developments in global financial markets, instructing them to brief him regularly on the situation.“We’re watching this very closely,” Jared Bernstein, a member of the White House’s Council of Economic Advisers, said on Wednesday at the Peterson Institute for International Economics. “The president’s being kept up on all the developments.”When asked about the cuts this week, the White House press secretary, Karine Jean-Pierre, said the administration would leave British policy to Ms. Truss’s government. But other administration officials have criticized the plan.Speaking at an event at the Brookings Institution on Wednesday, Gina Raimondo, the secretary of commerce, said Britain’s combination of cutting taxes and increasing spending would neither help the country fight inflation in the short term nor send it in the direction of long-term growth.“Investors, businesspeople want to see world leaders taking inflation very seriously, and it’s hard to see that out of this new government,” she said, adding, “We’re pursuing a different strategy.”Ana Swanson More

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    Why the British Pound Continues to Sink

    Britain’s pound coin — rimmed in nickel and brass with an embossed image of Queen Elizabeth II at the center — could always be counted on to be significantly more valuable than the dollar.Such boasting rights effectively came to an end this week when the value of the pound sank to its lowest recorded level: £1 = $1.03 after falling more than 20 percent this year.The nearly one-to-one parity between the currencies sounded the close of a chapter in Britain’s history nearly as much as the metronomic footfalls of the procession that carried the queen’s funeral bier up the pavement to Windsor Castle.“The queen’s death for many people brought to an end a long era of which the soft power in the United Kingdom” was paramount, said Ian Goldin, professor of globalization and development at the University of Oxford. “The pound’s demise to its lowest level is sort of indicative of this broader decline in multiple dimensions.”The immediate cause of the pound’s alarming fall on Monday was the announcement of a spending and tax plan by Britain’s new Conservative government, which promised steep tax cuts that primarily benefited the wealthiest individuals along with expensive measures to help blunt the painful rise in energy prices on consumers and businesses.The sense of crisis ramped up Wednesday when the Bank of England intervened, in a rare move, and warned of “material risk to U.K. financial stability” from the government’s plan. The central bank said it would start buying British government bonds “on whatever scale is necessary” to stem a sell-off in British debt.The Bank of England’s emergency action seemed at odds with its efforts that began months ago to try to slow the nearly 10 percent annual inflation rate, which has lifted the price of essentials like petrol and food to painful levels.Rising Inflation in BritainInflation Slows Slightly: Consumer prices are still rising at about the fastest pace in 40 years, despite a small drop to 9.9 percent in August.Interest Rates: On Sept. 22, the Bank of England raised its key rate by another half a percentage point, to 2.25 percent, as it tries to keep high inflation from becoming embedded in the nation’s economy.Energy Bills to Soar: Gas and electric charges for most British households are set to rise 80 percent this fall, further squeezing consumers and stoking inflation.Investor Worries: The financial markets have been grumbling with unease about Britain’s economic outlook. The government plan to freeze energy bills and cut taxes is not easing concerns.The swooning pound this week has carried an unmistakable political message, amounting to a no-confidence vote by the world’s financial community in the economic strategy proposed by Prime Minister Liz Truss and her chancellor of the Exchequer, Kwasi Kwarteng.To Mr. Goldin, the pound’s journey indicates a decline in economic and political influence that accelerated when Britain voted to leave the European Union in 2016. In many respects, Britain already has the worst performing economy, aside from Russia, of the 38-member Organization for Economic Cooperation and Development.“It’s just a question of time before it falls out of the top 10 economies in the world,” Mr. Goldin said. Britain ranks sixth, having been surpassed by India.Eswar Prasad, an economist at Cornell University, said this latest plunge had delivered a bracing blow to Britain’s standing. A series of “self-inflicted wounds,” including Brexit and the government’s latest spending plan, have accelerated the pound’s slide and further endangered London’s status as a global financial center.Dozens of currencies, including the euro, the Japanese yen and the Chinese renminbi, have slumped in recent weeks. Rising interest rates and a relatively bright economic outlook in the United States combined with turmoil in the global economy have made investments in dollars particularly appealing.But the revival by the Truss government of an extreme version of Thatcher and Reagan-era “trickle-down” economic policies elicited a brutal response.“The problem isn’t that the U.K. budget was inflationary,” wrote Dario Perkins, a managing director at TS Lombard, a research firm, on Twitter. “It’s that it was moronic.”To some, the pound’s journey indicates a decline in Britain’s economic and political influence.Suzie Howell for The New York TimesDuring the more than 1,000 years in which the pound sterling has reigned as Britain’s national currency, it has suffered its share of ups and downs. Its value in the modern era could never match the value of an actual pound of silver, which in the 10th century could buy 15 cows.Over the centuries, British leaders have often gone to extraordinary lengths to protect the pound’s value, viewing its strength as a sign of the country’s economic power and influence. King Henry I issued a decree in 1125 ordering that those who produced substandard currency “lose their right hand and be castrated.”In the 1960s, the Labour government under Harold Wilson so resisted devaluing the pound — then set at a fixed rate of $2.80, high enough to be holding back the British economy — that he ordered cabinet papers discussing the idea to be burned. In 1967, the government finally cut its value by 14 percent to $2.40.Other economic crises thrashed the pound. In the 1970s, when oil prices skyrocketed and Britain’s inflation rate topped 25 percent, the government was compelled to ask the International Monetary Fund for a $3.9 billion loan. In the mid-1980s, when high U.S. interest rates and a Reagan administration spending spree jacked up the dollar’s value, the pound fell to a then record low.The pound’s dominance has been waning since the end of World War II. Today, the global economy is experiencing a particularly tumultuous time as it recovers from the aftermath of the coronavirus pandemic, supply chain breakdowns, Russia’s invasion of Ukraine, an energy shortage and soaring inflation.As Richard Portes, an economics professor at London Business School, said, currency exchanges have enormous swings over time. The euro was worth 82 cents in its early days, he recalled, and people referred to it as a “toilet paper” currency. But by 2008, its value had doubled to $1.60.What might cause the pound to revive is not clear.The Truss government’s economic program has forcefully accelerated the pound’s slide — the latest in a series of what many economists consider egregious economic missteps that peaked with Brexit.Much depends on the Truss government.“The plunge in the pound is the result of policy choices, not some historical inevitability” said Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics. “Whether this is a new, grim era or just an unfortunate interlude depends on whether they reverse course or are kicked out at the next election.”As it happens, the Bank of England is preparing to issue new pound bank notes and coins featuring King Charles III, at the very moment that the pound has dropped to record lows.“The death of the queen and the fall of the pound do seem jointly to signify decisively the end of an era,” Mr. Prasad of Cornell said. “These two events could be considered markers in a long historical procession in the British economy and the pound sterling becoming far less important than they once were.” More

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    As Soaring Prices Roil Britain, Its Leader Vacations and a Likely Successor Sidesteps the Issue

    Britain is facing multiple economic shocks, from soaring energy prices to the hollowing out of the labor market by Brexit. But these issues seem disconnected from the fight to replace Boris Johnson.LONDON — The last time Britain suffered double-digit inflation, in 1982, Margaret Thatcher was prime minister, the nation was about to go to war with Argentina over the Falkland Islands, nurses and miners went on strike, and Prince William was born to Prince Charles and his wife, Princess Diana.This week, Britain is again in upheaval, with an inflation rate of 10.1 percent in July, a looming recession and a Conservative Party in the throes of a rancorous campaign to choose a new leader. If, as expected, Liz Truss is elected next month, she would take power during a period of economic stress comparable to what Thatcher confronted. And yet the multiple shocks Britain faces — from soaring energy prices because of the war in Ukraine, supply-chain disruptions after the coronavirus pandemic, and the hollowing out of the British labor market by Brexit — seem strangely disconnected from the contest to replace Prime Minister Boris Johnson.The untethered nature of the campaign is all the more striking because Britain is faring worse economically than its major European neighbors, not to mention the United States. Stagflation, another bleak relic of Thatcher’s early years, seems likely to haunt whoever succeeds Mr. Johnson.Ms. Truss, the foreign secretary, has stuck to an agenda focused on cutting taxes, which could aggravate rather than help solve those problems. Her goal is to appeal to the affluent, older Conservative Party members who choose the leader — a strategy that has helped her amass a so-far-unassailable lead over her opponent, Rishi Sunak, the former chancellor of the Exchequer. In polls of party members, Ms. Truss has an advantage over Mr. Sunak of between 22 and 38 percentage points.Liz Truss, the foreign secretary and a Conservative candidate for prime minister, campaigning last week in Cheltenham.Neil Hall/EPA, via Shutterstock“The whole campaign has been conducted in this bubble of unreality,” said Tim Bale, a professor of politics at Queen Mary, University of London. He blamed the problem in part on the news media, which he said had failed to pin down the candidates on how they would confront inflation.“There’s also a degree of fatalism about the crisis,” Mr. Bale added. “It’s put down to external events, and — by some — to the Bank of England’s tardy response.”The blinkered nature of the debate, analysts say, also reflects the peculiarities of the British political system. Only rank-and-file members of the Conservative Party can vote for the next leader, a constituency estimated at around 160,000 people. Older, whiter, and wealthier than most Britons, these voters are far less vulnerable to the ravages of a cost-of-living crisis than the broader population. To this rarefied slice of the electorate, Ms. Truss’ promise of tax cuts is more alluring than stark warnings that Britain needs to batten down the hatches before an approaching storm.Mr. Johnson, for his part, is on vacation in Greece, having skipped the chance to hold a crisis meeting with his would-be successors, as George W. Bush famously did during the presidential campaign in 2008, when he summoned Barack Obama and John McCain to the White House to discuss an emergency plan to confront the financial crisis.Pedestrians walked past shuttered retail stores on Oxford Street in central London on Tuesday.Andy Rain/EPA, via Shutterstock“It is pathetic that we have a government in which the leader is on a paid holiday, while the candidates to succeed him are just talking about pure nonsense,” said Jonathan Portes, a professor of economics and public policy at Kings College London. “The only person who seems to be thinking seriously about this is Gordon Brown.”Mr. Brown, a former Labour prime minister who led Britain’s response to the 2008 crisis, wrote recently that Mr. Johnson and the two candidates should agree on an emergency budget to cushion the blow of looming fuel price increases. Otherwise, he said, they would risk consigning “millions of vulnerable and blameless children and pensioners to a winter of dire poverty.”The inflation data, Mr. Portes said, showed that Britain was suffering from the “worst of both worlds.” It has been hit by the soaring fuel prices that have afflicted other European countries. The European Union said on Thursday that inflation in the 19 countries that use the euro rose to a record 8.9 percent in July. But it was lower in France, where the government has capped fuel prices.Britain also has the acute post-Covid labor market shortages that have plagued the United States, putting pressure on wages. In Britain’s case, those shortages have been aggravated by Brexit, which has reduced the influx of migrant workers from elsewhere in Europe.Ms. Truss has pledged aid to people who will be hard hit by the next planned increase in household fuel bills, in October, though she has refused to be drawn out on what such a package would look like. She has also raised the prospect of reviewing the anti-inflation mandate of the Bank of England, Britain’s central bank. It has come under fire in recent days for failing to act quickly enough to stem spiraling prices.Rishi Sunak, the other candidate to lead the Conservative Party, spoke during a campaign event last week in Cheltenham.Toby Melville/ReutersThe bank recently hiked interest rates sharply, and it is expected to double them again in the next six months. Yet the bank predicts that inflation will keep rising until it peaks at 13.2 percent in October, while it forecasts that a tighter money supply will plunge the economy into a recession that it says will last through 2023.Mr. Sunak also holds out the promise of lower taxes, though he argues that the government must tame inflation before it passes tax cuts. He has accused his opponent of fairy-tale economics. Ms. Truss counters that swift tax cuts will stimulate commercial activity and offer the surest path out of the economic wilderness.Economists, however, warn that cutting taxes would further strain Britain’s public services, most notably the National Health Service, which is already frayed after the pandemic.“It is hard to square the promises that both Ms. Truss and Mr. Sunak are making to cut taxes over the medium term with the absence of any specific measures to cut public spending and a presumed desire to manage the nation’s finances responsibly,” said Carl Emmerson, the deputy director of the Institute for Fiscal Studies, a research organization that just published a report on the government’s deteriorating finances.On Wednesday, as the new inflation numbers were announced, Ms. Truss was in Belfast, vowing to pass legislation on trade in Northern Ireland that is likely to ignite a new round of post-Brexit tensions with the European Union.Other than its effect on Northern Ireland, the role of Brexit in Britain’s woes is also largely absent from the campaign. Both candidates are appealing to the Brexiteer wing of the Conservative Party, especially Ms. Truss, who opposed the 2016 referendum to leave the European Union, but now displays the fervor of a convert.Prime Minister Boris Johnson, left, attempted to talk to a worker who spoke no English, as he helped to pack broccoli during a visit to a farm in southwest England in June. Brexit has caused a hollowing out of the British labor market.Justin Tallis/Agence France-Presse, via Pool/Afp Via Getty ImagesIn truth, there is lively debate among economists about how much Britain’s inflation can be blamed on Brexit. Mr. Portes said it was not a key driver but has “increased pressure on the margins” by worsening labor shortages, depressing the value of the pound, and raising the costs of imports, owing to customs paperwork.Adam Posen, an American economist who once served as an external member of the Bank of England’s Monetary Policy Committee, estimated in May that 80 percent of Britain’s inflation could be blamed on Brexit, mainly because of the loss of European migrant labor. This week, he stood by his aggressive claim.“Events have sadly played out about how I and others forecast,” Mr. Posen said. More