Tag Archives: monetarypolicy

Liz Truss: The Great Resignation and its Impact on UK Policy & Economy

Following the resignation of Boris Johnson, Liz Truss distinguished her leadership campaign by her commitment to deliver “growth, growth, growth”. In reflection, Truss’s brief stint in office was disastrous for the British economy. 

Truss’ ‘growth plan’ included cancelling a planned increase to corporation tax, reversing a rise in National Insurance Contributions, cutting the basic rate of income tax and abolishing the higher rate completely. Truss’ policies culminated in an unfunded £45 billion tax cut in her Chancellor of the Exchequer, Kwasi Kwarteng’s mini-budget.

Truss’ rationale seemed to invoke a renaissance of neo-liberal economic policies to fight inflation and stimulate economic growth. Previously supported by Ronald Reagan and Margaret Thatcher, neo-liberal economics purports minimal state intervention, deregulation and confidence in free markets. These austerity-driven financial policies favour the wealthy, and were unsurprisingly met with enormous public backlash in the UK against the current macroeconomic backdrop. In the midst of a cost of living crisis, stagnant growth and an energy crisis, Truss’ plans for the economy were seen as unorthodox by some and frankly naïve and reckless by many.  Upon the news of Kwarteng’s mini-budget, the pound dropped to the lowest level ever against the dollar, UK government bonds saw a heavy sell-off and the FTSE ended the day deep in the red. The Bank of England’s decision to intervene and purchase £65 billion of long-dated gilt was the calamitous culmination to a string of bad days for the British economy.

The backlash culminated in Truss sacking Kwarteng, only to step down herself 6 days later. Truss’ 44 day stint in office makes her the shortest-serving British prime minister in modern history. 

Her resignation has shaken the economy of Britain as it faces a worsened cost of living crisis as well as a looming recession. The election of the more economically moderate Rishi Sunak to No.10 has had somewhat of a calming effect on the economy with the pound stabilising. 

Sunak has outlined that difficult decisions lie ahead as he intends to cut spending. Jeremy Hunt, Chancellor of the Exchequer, warns that the new budget being prepared, is ‘going to be tough”.  

After weeks of financial turmoil, expectations for a recession have intensified and forecasts for its extent deepened.  While the appointment of Sunak has eased economic uncertainty and tensions in the bond market, the country still faces a profound economic challenge with a fourth-quarter GDP decline of 1.6%, predicted by Goldman Sachs’ economists. 

To curb inflation, it is expected that the Bank of England will increase monetary contractions by hiking interest rates 75 basis points in November and December. This will hopefully cool the economy enough to calm inflation and panic.

Truss’ brief stint as PM shows that neoliberal economic policies remain unpopular.  They are particularly unwelcome in economically challenging times and can even be term-ending for its proponents in power. With Sunak we can expect less turbulence but the outlook is still negative for the British economy as businesses and citizens alike brace themselves for tightening monetary policy.

Fiscal vs Monetary Policy: The UK’s Dilemma.

“In this jittery environment – there could be no reasons for more jitters”

Despite the IMF chief’s call for no “more jitters”, the sacking of the UK’s Chancellor on Friday (14/10), alongside a further fiscal policy U-turn, dashed their hopes of steady progress. But, how did we get here?

Kwasi Kwarteng’s mini-budget announcement in mid-September had a ‘pro-growth,’ ‘expansionary’ headline, but caused concern due to its financing and lack of approval by the Office for Budget Responsibility (OBR). The potentially unsustainable budget deficit, and the expansionary fiscal stance which conflicted with the Bank of England’s (BoE) deflationary policies led markets to price in higher interest rate rises, therefore reducing the price of gilts (government bonds).

However, panic spread due to pension funds’ heavy collateralisation through gilts, leading to calls for more collateral, and a mass sell-off of gilts by these funds. This sparked a downward spiral, causing further falls in gilt prices and igniting fears of a ‘run.’

Therefore, to prevent mass defaults on pension funds, and safeguard the finances of connected banks, the BoE stepped in and purchased these gilts, reducing the yield (i.e. the interest rate). But, like many G20 Central Banks, the BoE is tightening monetary policy to ward off inflation. Hence, this move served to undermine their credibility and muddy their inflation-targeting objectives. The announcement that the BoE would stop this bond-buying procedure on Friday should have re-established their policy tightening strategy and credibility, ultimately helping to re-stabilise market expectations. However, the sacking of Kwarteng, and the U-turn on the mini-budget, including a backtrack on the proposed decline in corporation tax, meant that a gilt sell-off re-started and prices fell, while currency markets remained turbulent. Truss’ fragile position as Prime Minister is likely to continue driving financial instability.

Alleviating This Uncertainty Via Communication

There are multiple issues stemming from this crisis in policy, but some uncertainty could be resolved through communication. Despite having no other option, Andrew Bailey (Governor of BoE) put himself in a difficult position on Wednesday by announcing the termination of gilt-buying on Friday. As long as the action was taken, the power of strong communication is illustrated here, as this helped stabilize expectations, and shore up BoE credibility as an inflation-targeter. On the other hand, Kwarteng’s failure to pre-warn business leaders about the mini-budget scared markets, unraveling the negative shocks. Furthermore, these shocks were amplified as he reportedly did not communicate certain elements with cabinet ministers, and failed to include the OBR.

Until Friday, there appeared to be coherence between No. 10 and No. 11, however Bailey’s “you’ll have to ask the Chancellor,” response to questions regarding Kwarteng’s absence from an IMF meeting, and early departure from the conference on Thursday, highlighted growing tensions between the BoE and UK politicians; giving further insight into the conflict between fiscal and monetary policy in the UK.

The Blame Game: Not So Independent.

While the past few weeks have seen monetary and fiscal policy work in opposite directions, Georgieva’s comments that fiscal policy should not undermine monetary policy illustrated the importance of the latter. That said, the Bank of England’s actions following unreasonable fiscal policy illustrates the opposite of this, unbalancing the see-saw of whether fiscal policy should support monetary policy (or vice-versa). Meanwhile, the independence and credibility of the BoE has been threatened, both by fiscal policy, and the risking of moral hazard through its recent buying of gilts. This illustrates a need for strong communication from monetary and fiscal policy makers in order to regain stability and transparency. Ultimately, if we are to learn from the 1970s, monetary policy needs to be allowed to lead, with politics stepping in to support those who will be hurt. This forces a dilemma for myopic politicians regarding the seemingly correct (in the long-run), but unpopular action to take.


Yesterday’s (Monday 17/10) events seemed to be taking this route, with financial markets stabilizing. On the other hand, some argue that the new Chancellor went too far, and that through tearing up Truss’ entire ‘manifesto,’ he is now the de-facto Prime Minister. Furthermore this has led to calls for a general election and stemmed questions of whether credibility can ever be restored to Truss’ leadership. Again, the lesson may be one of communication, but only time will tell whether trust can be regained once this breaks down – and until that point, political instability will continue to undermine the financial and monetary stability of the UK.

Recession Talk: The OECD Forecasts for the European Economy 

On Monday 26th September, the Organisation for Economic Cooperation and Development (OECD) released their forecasts for the global economy. The outlook is bleak. International output growth is projected to grow at a rate of 2.2% over 2023, down from initial projections of 2.8% growth for 2023. This contrasts negatively to a growth rate of 3% in 2022 and represents an even greater fall from 6% growth in 2021. The Russian invasion of Ukraine, the ongoing effects of China’s Zero Covid Policy, as well as an increase in interest rates by the ECB, Federal Reserve, and Bank of England, have been identified as the main causes of this sluggish economic activity. The OECD identifies the Russian invasion of Ukraine as a key contributor to these negative forecasts – with forecasts outlining a $2.8 trillion decrease in global GDP thanks to the invasion. It also notes that the economic impact of the War is greater than previous forecasts predicted.

As a result, ECB policy has transitioned away from negative interest rates. This tightening of monetary policy has led to a decrease in the money supply, alleviating pressure on prices. This has also been cited as a primary contributor for slower economic growth over the next calendar year. 

The OECD predicts that because the US Fed started contractionary monetary policy earlier, their high inflation levels will decline more swiftly than those of Europe and the UK.

The OECD also notes the impact of reduced energy supplies from Russia to the EU. Gas storage levels have recently been recorded at 90% of capacity in the EU. However, projections indicate that this initiative will not be sufficient on its own to assist households through the Winter. A serious reconsideration of energy usage in Europe is pivotal and new European policy must acknowledge the necessity of reducing gas consumption. The OECD projects that European growth could fall by a further 1.25% points relative to their initial forecasts for 2023 if supply is not better diversified and gas consumption reduced. This, together with increasing inflation, would plunge several European economies into recession in 2023 if European leaders do not properly confront the energy crisis.

Although slow and laborious growth is predicted for the Eurozone, a recession is unavoidable if gas consumption cannot be reduced or if problems arise with other energy suppliers to the European countries. The outlook for the UK looks even more bleak with the OECD projecting zero growth. Germany’s dependence on Russian energy supplies has seen the OECD project a contraction in its economy for 2023. The outlook looks bleak indeed.

End of an Era: The ECB Waves Goodbye to Negative Interest Rates

In July of this year, the European Central Bank (ECB) ended its historic eight-year policy of negative interest rates. Motivated by the European debt crisis, the ECB slashed interest rates below zero in an effort to push banks to lend more and boost economic growth in June 2014. An unorthodox approach to monetary policy—the announcement made headlines for its experimental attempt to prop up a eurozone economy that was showing strong signs of deflation.

What do negative interest rates mean?

One of the primary responsibilities of central banks is to make it more or less attractive for households and businesses to save or borrow. They achieve this through the use of monetary policy tools such as interest rates. The implementation of negative interest rates by the ECB appeared to be a rewriting of the conventions of economics at the time of its introduction. Banks have traditionally operated in such a way that savers earn interest on deposits and borrowers pay interest on loans. Interest rates of below zero flip this concept on its head, with lenders paying to hold their money on deposit in the bank while borrowers are paid to take on loans.

Sub-zero: A failed experiment?

As the era of the negative interest rates experiment has now drawn to a close in the eurozone, the results of the policy have been mixed with slow growth. The ECB has estimated that extra bank lending increased by an average of 0.7 per cent and that the policy created an extra 0.4 to 0.5 percentage points of economic growth. But the policy was not entirely well received by member states. Critics of the policy felt that it created asset bubbles and encouraged cash hoarding. Other opponents felt it unfairly hurt the yield on European pension savings. The Bank of Japan (BoJ) is now the only remaining central bank adopting negative rates. Despite pressure to protect the strength of the Yen, the BoJ continues to stick to dovish monetary policy as underlying demand remains weak and inflation remains low at 3 per cent.

Inflation running rampant

The decision by monetary policymakers to increase interest rates has come amidst a rapid surge in eurozone inflation. Record high price levels have induced ECB president, Christine Lagarde, to make a U-turn on the policy of negative interest rates, with the ECB raising rates for the first time in 11 years last July.

Up until then, the ECB was charging banks minus 0.5 per cent on surplus deposits before moving the key rate to zero. Rates were hiked further in September by a record margin of 75 basis points on the back of inflation of 9.1 per cent in August. The ECB is expected to continue to increase rates in the coming months to bring inflation back down towards the bank’s target of 2 per cent. Philip Lane, the ECB’s Chief Economist, has signalled that planned future increases will likely come in smaller increments.

Europe’s 25-year inflation high is largely driven by soaring energy prices, which are rising at an annual rate of 38.3 per cent, due to Russia’s invasion of Ukraine. Around the world, monetary policymakers are turning to hawkish rate hikes to wrest control of surging prices. US Federal Reserve Chair Jerome Powell lifted interest rates by a third consecutive three-quarter basis point yesterday with further tightening planned. The Fed forecasts the benchmark rate to rise to 4.4 per cent by the end of the year.

When it comes to interest rate hikes, monetary policymakers have to tread carefully. A fine balancing act is required as aggressive efforts to curb spending may run the risk of triggering a large and deep recession.