Two years have passed since the UK financial crisis that shook the nation following Liz Truss and Kwasi Kwarteng’s “mini” Budget. As the UK prepares for another Budget, memories of the tumultuous events of the past resurface, prompting reflection and lessons to be learned. Let’s delve into the saga that unfolded and explore the aftermath.
Potted History:
– Liz Truss emerged as a leading candidate for prime minister after Boris Johnson’s resignation in July 2022, advocating tax cuts that raised concerns about the UK’s fiscal stability.
– The dismissal of the head of the Treasury, defiance of fiscal rules, and the unconventional approach taken by Truss and Kwarteng set the stage for economic turbulence.
– The “mini” Budget on September 23, 2022, led to increased government borrowing costs and a weakened pound, culminating in a crisis that prompted intervention from the Bank of England.
– Market volatility, forced selling by pension funds, and criticism from the IMF added to the chaos, ultimately resulting in a significant financial reckoning.
Financial Market Effects:
– The spike in government bond yields, dubbed the “moron risk premium” by Dario Perkins, highlighted the downward spiral of UK assets and foreign investor unease.
– The BoE’s actions and market expectations played a crucial role in stabilizing the situation, albeit temporarily.
– Despite the crisis, UK inflation expectations remained relatively stable, indicating concerns beyond government default.
Who Did It?:
– Reports and analyses suggest a combination of fiscal policy decisions, forced selling by pension funds, and global yield movements as key contributors to the crisis.
– Opinions differ on the exact proportions of each factor, but consensus points to Truss’s disruptive leadership style and the LDI crisis as pivotal triggers.
Good Crisis, Bad Crisis:
– Governor Bailey and the BoE’s swift response averted a deeper crisis, showcasing effective crisis management.
– The ousting of Truss and acknowledgment of institutional failures underscored the need for responsible leadership and regulatory oversight.
– Lessons learned from the episode emphasize the importance of prudent policymaking, regulatory vigilance, and the role of economic institutions in preserving financial stability.
Lessons:
– Avoid risky policy maneuvers and prioritize regulatory safeguards to mitigate potential crises.
– Acknowledge the central bank’s role as a last resort market maker and address associated moral hazards proactively.
– Respect and uphold economic institutions to prevent market disruptions and ensure stability.
– Exercise caution in fiscal decisions to prevent future economic shocks while maintaining institutional integrity and sound forecasting.
– Stay informed about emerging economic trends and be vigilant about potential risks to safeguard financial stability.
Reflecting on the past turmoil serves as a reminder of the fragility of economic systems and the critical role of prudent governance and regulatory oversight in averting crises. As we look towards the future, let us heed the lessons learned and strive for resilience and stability in our economic endeavors.
