Long Read  

The economic challenges facing Liz Truss’s government

The economic challenges facing Liz Truss’s government
(Photo by Dan Kitwood/Getty Images)

Liz Truss took office after the biggest economic convulsion the world has ever seen, during a shooting war in Ukraine, with inflation in double digits and an economy heading for recession — an economy, moreover, that has persistently underperformed relative to its peers.

Many in her shoes would run a mile. To succeed, she will need nerves of steel, a healthy dose of good luck, the support of her party and, above all, good advice.

Good advice starts with clarity. How did we get here?

In 2007, the UK economy seemed to have found the formula for success. That was reflected in asset prices: you could get $2.10 for one pound. Now it is $1.15. 

But sterling was overvalued back then, because of the banks. Banks were in fashion. That is where the money was, where the smart people worked. That is where innovation was happening.

The UK led the major economies in the share of banking in the whole economy, encouraged by ‘light-touch’ regulation, an extremely favourable inflation and interest rate environment and excessively loose fiscal policy, with the government running a deficit during a boom. 

It could not last, and it did not.

The great financial crisis of 2008-09 corrected that overvaluation. Banking equities collapsed and so did the value of sterling. Neither have recovered since.

After the GFC, the UK ‘recovery’ was practically non-existent, thanks to our disjointed and unambitious policy choices. The mix of tight fiscal policy and loose monetary policy, including unconventional monetary loosening, was not in itself flawed.

But the Troubled Asset Relief Program in the US worked much better than the UK’s austerity combined with the Bank of England’s ‘work-to-rule’ version of unconventional monetary policy (quiet-quitting quantitative easing).

GDP collapsed during the GFC, and productivity growth – already unremarkable – all but disappeared afterwards. 

Short-term remedies

Low rates can haul an economy out of recession, but they undermine productivity growth in the long term, by suppressing the gales of creative destruction and encouraging the zombification of the economy.

Monetary meds are addictive and damaging to your health in the long term. They should be applied in scale when they are essential, and then removed as soon as feasible afterwards.

The same applies to fiscal meds: take them when you must and then stop. After anaemic growth post-GFC, the budget of 2013 applied another dose and unlocked a short boom, thanks to a cynical juicing of house prices through the Help-to-Buy scheme.

That budget reeked of short-term political rather than long-term economic imperatives. It probably won the 2015 election for the Conservatives, but it committed the UK to an even lower long-run growth path.

In the long term, the drugs of demand management via macro policy do not work, they just make you worse.

Then the 2015 election brought us the Brexit referendum, the result of which caused sterling to tank again and business investment – already weak compared with the UK’s peers – to flatline, or worse, ever since.