Liz Truss, the incoming prime minister, has sought to assuage jitters by reaffirming her commitment to central bank independence, to raising the growth rate of the economy, and to reversing supply-constraining tax hikes. But as the scale of the energy crisis and likely interventions have crystallised, the cost of government borrowing has jumped.
In recognition, Kwasi Kwarteng must soon set out a longer-term framework for ensuring fiscal probity – and that requires him regripping government spending.
Our editor likens this moment to war. Clearly, the scale of the energy shock and its impact on borrowing is a highly unusual crisis situation, with talk even of price controls and rationing. While those are undesirable, there will inevitably be large borrowing. Spreading the financial costs of this over time, akin to war debts, is prudent.
Yet after wars, demobilisation typically means sharp spending cuts and then entrenched fiscal discipline. Every government ran a primary budget surplus (with revenues exceeding spending excluding interest costs) from 1948 until 1967. After the Napoleonic Wars, the UK ran primary surpluses every year from 1815 right through 1899. For context: we’ve not run a primary surplus now since 2001.
What markets ultimately care about is this long-term commitment to sustainable budgeting, not emergency borrowing. We’ve just lived through the fiscal effects of the Covid-19 pandemic and are going to cancel tax rises worth tens of billions of pounds per year.
To then cushion the effects of the energy price spike and raise defence spending, on top of the demands of an ageing population, is it any wonder borrowing costs are rising? A medium-term plan for spending restraint to avoid spiralling debt is necessary.
Truss initially made two policy commitments on this, with one further indication from her Chancellor. The first commitment was for a spending review later this year. The second was to ensure that public spending grows less quickly than the private sector over time
The more recent indication is that Kwarteng will also overhaul Rishi Sunak’s fiscal rules, trading shorter term budgetary loosening for longer-term tightening. He has implied that a new target will focus on getting the debt-to-GDP ratio back falling again.
Let’s work backwards through these.