Uk Economic Crises: What’s happening with the UK economy?
Liz Truss, the new Prime Minister of the United Kingdom, announced a large tax cut package, triggering a currency crisis.
Prime Minister Liz Truss of the UK announced a plan to lower taxes on high earnings ten days ago, but today the government changed its mind. British markets quickly rebounded, but long-term doubts about the UK economy remain.
The UK experienced its most severe currency crisis in recent memory last week. Additionally, there is a cost-of-living crisis on top of the Bank of England’s enormous inflation, which it has yet to considerably reduce. The UK economic crises threw the world’s financial markets for a loop. The UK’s economy has fallen into deep trouble as a result of Prime Minister Liz Truss’s recent UK tax cut proposal, even though the current crisis has been fuelled by a number of other reasons, including the economic effects of Brexit.
Kwasi Kwarteng announced the largest tax cuts in the UK in fifty years
On September 23, Kwasi Kwarteng, Chancellor of the Exchequer under Truss, announced the largest tax cuts in the UK in fifty years, at an estimated cost of 45 billion pounds over five years. In addition to announcing a rollback of corporation tax increases and a rise in prices for national insurance, the so-called “mini-budget” suggested tax cuts for the United Kingdom’s wealthiest incomes and promised that both measures would take effect the next year. In an effort to encourage more home purchases, Kwasi Kwarteng and Liz Truss’ plan also lowers the stamp tax, a charge on property sales in Northern Ireland and England.
Global markets reacted by dumping off United Kingdom -backed assets, driving the pound to its lowest-ever value against the dollar at $1.03 before it gradually increased later in the week. The new economic strategy, called “Trussonomics” in reference to Reaganomics, the supply-side economic policies enacted under Ronald Reagan in the 1980s, was overwhelmingly rejected by investors.
Insisting that the UK tax cuts will encourage more economic investment, Liz Truss and Kwasi Kwarteng have remained by their choice to lower taxes on some of the wealthiest Britons and provide unique incentives for businesses, including tax cuts and regulatory rollbacks. It’s a 21st-century application of trickle-down economics that’s taking place in the context of widespread inflation and rapidly rising oil prices.
What caused the financial crisis in the UK?
The mini-budget was implemented against the acknowledged reasoning of most major economists – and without the usual political safeguards. On September 8, Truss fired Tom Scholar, a long time government employee who served as the permanent secretary to the Treasury, opening the door for her to challenge what she called “Treasury orthodoxy” — the conventional economic view that has influenced the Treasury’s strategy to taxes and government spending and with which, in her opinion, has contributed to UK economic crises
The dismissal of Scholar was largely regarded as a political ploy that not only cost the government a renowned technocrat during a trying economic time, but also compromised the impartiality of the United Kingdom’s civil service. According to a National Institute of Economic and Social Research review of the plan, the government also asked that now the Office for Budget Responsibility (OBR) not conduct any impartial analysis of the proposal.
The timing of the tax cuts could not have been worse.
UK Inflation on a worldwide scale, stagnant wages, and a slower-than-anticipated economic revival first from Covid-19 pandemic were all issues that the United Kingdom had already been facing. Add in an energy crisis in the midst of one of the worst summers on records, and a UK recession 2023 seemed all but certain.
The cost of living crisis has been worsened by the UK currency crisis, despite the fact that these and other contributing factors have also played a role.
And, according to Nikhil Sanghani, managing director of research at the Official Monetary and Financial Institutions Forum (OMFIF), the most recent precipitous drop in the pound’s value is a direct result of Kwasi Kwarteng and Liz Truss’s tax cuts and mini-budget.
The highest earnings in the United Kingdom will benefit from the tax reduction. The new legislation from Kwasi Kwarteng reduces the 45 percent income tax category, which was formerly the highest, for income over 150,000 pounds. The highest tax rate is now 40 percent, which applies to incomes over 50,271 pounds.
According to the Guardian, this will result in annual savings of 9,187 pounds for the wealthiest households. The economy will receive around 19 billion pounds as a result of the cancellation of a proposed corporate tax rise from 19 percent to 25 percent, which Kwasi Kwarteng said could be used to “reinvest, create employment, enhance wages, or pay dividends that sustain our pensions.”
Simply saying, the tax cuts inject more money into an economy that is already suffering from inflation, for which the conventional macroeconomic solution is for individuals to spend less, not more. Investors are racing to sell up their United Kingdom assets, including bonds and other holdings denominated in pounds, since they view the tax cuts as absurd and risky. This lowers the value of the pound.
According to Sanghani, “most orthodox economists don’t think this is a smart idea.” It’s difficult to square that one.
According to Mark Blyth, director of the William Rhodes Centre for International Economics and Finance at Brown University, “the market’s reaction to discovering that the risk inherent in the asset is considerably more than before realized because of Trussonomics” is why the pound is depreciating.
Government bonds, which are typically thought of as safe investments, experienced a sell-off following the declaration of Kwasi Kwarteng and Liz Truss’s new plan. This sell-off was so severe that the Bank of England, the United Kingdom’s central bank, intervened and bought 65 billion pounds worth of bonds “to restore orderly market conditions” and float the nation’s pension scheme.
The United Kingdom already has a heavy public debt load; without new taxes, the UK’s Office for Budget Responsibility said, public debt would rise to 320 percent of Britain’s GDP in 50 years from 96 percent, or 2.4 trillion pounds, at present. This can eventually result in less money being spent on public services.
According to Julian Jacobs, a senior economist at OMFIF, real wages in the United Kingdom are not in line with inflation despite Liz Truss implementing a price ceiling on energy expenses earlier in September, as in other countries. “The UK has witnessed an increase in strike activity — tube strikes, rail strikes — primarily as a result of pay stagnation,” he explained.
The International Monetary Fund (IMF) agrees, offering a stunning and nearly unusual condemnation of the tax cuts on Tuesday that further depreciated the pound. The international lender warned that “the nature of the United Kingdom measures will certainly increase inequality” and urged the administration to “explore ways to provide assistance that [are] more targeted and re-evaluate the tax policies, especially those that favor high-income earners.”
Adnan Mazarei, a former deputy director at the IMF, told the BBC that it is unusual for the fund to issue such a strong warning to the fifth-largest economy in the world. Instead, the fund usually makes such statements about “emerging market countries with problematic policies, but not often G7 countries.”
Is the UK going to go into recession?
Sanghani claimed that there might never have been a good time to enact tax cuts, but the present is particularly bad. He claimed that a tax plan that defies conventional wisdom is “the nail in the coffin in terms of, ‘Will there be a UK recession 2023?‘” On top of high inflation brought on in part by the Covid-19 stimulus, interest rates have increased to combat the UK inflation, and absurdly high energy prices brought on by Russia’s war in Ukraine.
On November 23, Kwasi Kwarteng will submit a new fiscal plan, but Rachel Reeves, the shadow chancellor of the exchequer for the Labour Party, encouraged the government not to wait until then. The government needs to act immediately, she said, and “this message from the IMF should sound warning bells.”
The tax cuts, according to Blyth and Sanghani, were solely a political choice. Never mind Reaganomics. As the Tories are thrown out of authority for the next ten years, this is only a “smash and grab” raid by them for their supporters, according to Blyth. According to YouGov polls conducted over the last nine months, Labour is clearly in the lead to form the next government. Voters appear prepared to dump the Conservative Party after a string of poorly handled catastrophes under Tory leadership, including Brexit, former Prime Minister Boris Johnson’s Covid-19 controversies and subsequent resignation, and the current cost-of-living and currency crises.
Given this, the reasoning behind the tax cuts is probably not going to change, and Liz Truss has up to this point maintained her plan.
Economic crisis in Uk
During talks with nearby BBC radio stations on Thursday morning, she stated, “We are facing really severe economic times.”
“That is a problem that we face globally. Growth won’t manifest itself right away. What matters is that we are improving this nation’s trajectory over the long run” she said
However, increasing the amount of money flowing into an economy that is already experiencing an inflation issue is nonsensical and goes against the Bank of England’s efforts to combat the UK inflation rate, which has increased seven times since December and is currently around 10%.
Another strategy to combat inflation is to impose income taxes, which also give the government the money it needs to pay for services like the British National Health Service and pensions for the elderly. Instead, Blyth claimed that the government “decide[d] to implement enormous tax cuts that may not even be really stimulatory given that the bias on who gets the money makes the Trump tax cuts appear like socialism.” “The folks who get all the money won’t spend it because they are already wealthy, and the others who need money to spend will get almost nothing and then get hit with a large increase in their mortgage payments and a doubling of their energy costs.”
The Labour Party led the Conservative Party by 33 points, according to Reuters.
According to the most recent YouGov poll, the new policies have also failed to win over voters. This is the highest polling the party has seen since the 1990s, and it suggests a potential opportunity to unseat the Tory party when national elections are held in 2024.
Liz Truss has reaffirmed her commitment to the economic plan, and it is unclear whether the harsh criticism from investors, the central bank, the IMF, and even voters will cause her to reconsider before more harm is done. However, Sanghani told Vox that “U-turn tax cut is the only true way to turn things around.”
Asserting the same, Blyth, director of the William Rhodes Centre for International Economics and Finance at Brown University urged the government to “stop executing amazing acts of self-harm”.
Will this have any effect on the position of the UK prime minister Liz Truss? Will she face severe consequences due to her economic proposals? Check the link below to find out.
