As the world’s policy makers gather in Washington for the International Monetary Fund’s Annual Meetings, there is a historical curiosity to consider. Roughly every 15 years since the 1930s, Britain has experienced an autumn financial crisis and policy regime change that has foreshadowed global upheavals a few years later.
Britain abandoned the gold standard in September 1931; the United States followed in 1933. The sterling devaluation of September 1949 ended postwar hopes of a genuinely multilateral currency system and confirmed the dollar’s hegemony. The second postwar sterling devaluation, in November 1967, triggered a chain reaction that culminated in U.S. President Richard Nixon dismantling the Bretton Woods currency system in 1971. Britain’s IMF bailout in September 1976 discredited Keynesian economics and led to the election of Margaret Thatcher, inspiring the monetarist revolution of Paul Volcker and Ronald Reagan. The breakup of the European exchange-rate mechanism on “Black Wednesday” in September 1992 forced France, Italy, Spain, and Greece to accept Germany’s economic dominance of Europe. And the run against Britain’s most aggressive mortgage lender, Northern Rock, in September 2007, became a template for the global financial crisis a year later.
Britain has just suffered its latest financial convulsion. The near-collapses of the pound, the country’s government bond market, and its pension system are likely to echo around the world in several unexpected ways.
Last month, I argued that Britain’s Conservative Party had outdone itself by finding in Liz Truss a prime minister even worse than Boris Johnson, Theresa May or David Cameron. But I also asked a paradoxical question about the politically disastrous experiment with “Trussonomics.” Was it possible that Truss’s bet on 1970s-style Keynesian stimulus and price controls might succeed, at least in the short term? Could some modified version of Britain’s unorthodox mixture of fiscal stimulus, price caps and energy subsidies become a model for other countries desperately trying to revive collapsing economies while keeping inflation at least temporarily under control?
Today it seems preposterous to suggest that Britain could become a model for economic revolution, as it did under Thatcher. Yet, looking beyond Truss’s political blunders, there are four features of her new economic policy that other countries could consider if they ever stop laughing at Britain.
First, the top priority for economic policy in a time of war and international energy upheavals may be to avert deep recessions, rather than worrying about inflation targets and debt dynamics. Second, under such conditions, inflation may be better managed with price controls and fiscal subsidies than with tight money. Third, a policy mix of bold fiscal expansion and moderate monetary tightening may succeed in avoiding an economic slump for a year or two and prepare the ground for an orderly tightening of monetary policy in the longer term. And, fourth, when inflation and debt levels increase unexpectedly, fiscal sustainability can become easier, not harder, to achieve.
All four of these statements are heretical, according to current economic orthodoxy. Yet all can be backed by plausible economic arguments and historical examples (albeit with plenty of counterarguments and counterexamples).
Consider “fiscal sustainability.” Suppose a government with 1% growth and 2% inflation aims for a debt-to-GDP ratio of 60%. Simple arithmetic shows that the government must keep its deficit below 1.8% of GDP to meet this definition of “fiscal sustainability.” Now suppose that growth is 1%, but inflation accelerates to 4% and the debt-to-GDP ratio rises to 90%. In that case, the government can borrow up to 4.5% of GDP and still keep the debt ratio unchanged.
But if there were plausible arguments for Britain’s new policies, why did they plunge financial markets into turmoil? The reason may lie in astonishing political and institutional blunders that almost guarantee the end of a long Conservative hegemony in British politics.
By combining a useful Keynesian stimulus with an economically irrelevant and politically toxic abolition of Britain’s top tax rate, Truss gave the impression that the new government’s true objective was to redistribute income from the poor to the rich. By insisting, without evidence, that her tax cuts would boost Britain’s long-term growth trend, rather than simply promising to avert a disastrous slump caused by the Ukraine war, she exposed herself to economic derision and set herself up for political failure when her supply-side miracle fails to happen.