Last Updated on October 19, 2022 by Karl Thompson
Liz Truss and then then chancellor Kwasi Kwarteng announced a mini-budget on September 23rd 2022 which outlined tens of billions of pounds of tax cuts:
- corporation tax was to be cut from 25% to 19%
- the basic rate of income tax from 20% to 19%,
- while the top 45% rate of income tax was also to be slashed for the extreme minority of higher income earners.
At the same time the budget also committed the government to an increasing in spending to fund the energy-price cap which also ran into several billions of pounds annually for two years.
This package of tax cuts amounted to a planned reduction in government income of £45 billion, and the budget included no mention of how this shortfall was to be funded.
The extreme negative market reaction to Truss’ Mini-budget
The financial markets reacted immediately and violently to the Tory mini-budget with the interest rates on government bonds increasing rapidly.
For example, the 30 year bond rate increased from 4% to 5% – this is the amount of interest the UK government pays on its debt, meaning the UK government would have to pay a lot more going forwards.
The value of the pound also fell relative to the dollar and other currencies meaning it would be more expensive for businesses and individuals to buy imports.
What are government bonds?
Bonds are government backed loans – the government issues bonds when it wants to raise money to pay for various investments – and they promise to pay interest to whoever buys these bonds.
Bonds range from short term (3 years) to the very long term – over 60 years and the interest rates on bonds vary according to primarily three factors:
- national interest rates – higher interest rates = higher interest payments (obviously!)
- inflation – higher inflation is correlated with higher interest rates so the same pattern as above
- a country’s credit rating – if a country is deemed to be at a higher risk of defaulting on its bonds, its credit rating drops and the interest payments go up.
The total value of UK government bonds, (in other words UK government debt) is at time of writing in October 2022 $2.6 trillion. (Also see source 1 below, for the latest UK Government data)
And huge debt also means huge annual interest payments, and so when bond rates increased by even just 1% as a result of the tragic Tory mini-budget, this means the UK government has to find tens of billions more every year just to service the interest on that debt, and this means less of our tax money going on public services.
The extent of government debt and why the Tory mini budget was so harmful
Even before the tragic mini-budget announcement Britain’s annual deficit stood at 2.3% of Britain’s GDP (according to latest government figures that’s £2.3 trillion) and so Britain was already spending approximately £50 more EVERY YEAR than it was bringing in in tax receipts.
The Tory mini-budget increase that deficit by around another £50 billion, meaning the total annual deficit would have been £100 billion, EVERY YEAR and the budget laid out no specific information about where that extra £100 billion was going to come from.
These policies would have had the further effect of feeding inflation, which had already been creeping up, and increasing interest rates which would have increased the cost of government borrowing while at the same time undermining the capacity of the government to pay the yield (interest rate) on its bonds.
Essentially the markets (i.e. the pension funds, countries and other companies who held UK Bonds (or debt)) looked at the Tory’s economic plan and said ‘there’s no way this is sustainable – you’re committing to running a national deficit of £100 billion a year with no indication of how you’re going to pay for it, which means you’re going to be less likely to pay back our debt, or the interest on our bonds’.
These policies which have since been reversed in a U-turn only two weeks after they were first announced (which completely undermines Liz Truss’ credibility as a leader and neoliberal economics more generally)
The Tory U-Turn
Shortly after the original mini-budget Liz Truss sacked her chancellor and appointed Jeremy Hunt in his place.
On Monday 19th of October, less than one month after the announcement of the original mini budget, Jeremy Hunt announced the scrapping of nearly all the measures outlined in that original budget, in what was the biggest U-turn in British economic history.
As it stands there will be no tax cuts after all and the energy price cap guarantee will only hold until April 2023, rather than a year after that as had been the case in the original disaster budget.
Relevance to A-level sociology
In my experience most A-level sociology students have very little understanding of economics, but personally I think every student needs at least a basic level of understanding of national economics, taxation, public spending, the sheer scale of national debt, interest rates and inflation.
Without an understanding of these basic economic concepts students are missing out on a deeper understanding of how economic structures and the ‘macro’ picture affect social life at a more personal level.
This material is most relevant to the Global Development module to illustrate how important economic globalisation is!
What this case study demonstrates is just how far the power of the British Government (and ANY government for that matter) has declined in relation to international bond markets and ratings agencies, because they are so massively in debt.
Britain owes so much money that it can now no longer do anything which undermines its capacity to repay that debt which is largely held by international financial corporations.
In this case the markets forced the UK to abandon its plans to cut taxes, and one might reasonably expect this means that the government would not be able to increase public spending either – because that would put a similar level of strain on the government’s capacity to pay back its enormous amount debt.
Interestingly one of the things Jeremy Hunt said in his ‘biggest U turn in political history’ speech was that….
“Governments can’t prevent market stability but they can manage the situation so that people don’t suffer – in terms of rising prices, mortgages and pensions”.
As a final word I also think maybe it illustrates the looming division between the old and the young… pension funds hold huge amounts of UK bonds and so these moves have been another strategy to protect the old while the young will pick up the costs again, as there are public spending cuts coming.
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Thanks for.the comment – I personally think we need more of a focus on redistribution and sustainability and work a debt right off into that – which would mean less of a return fr those holding bonds but more of a future for the young!
Good, detailed analysis of the impact of rising bond yields. In itself the spike in bond yields does not prove anything against Liberal economics or supply-side reform, as the market reaction was to the extra debt, not the policies in themselves (a separate intellectual case can be made for or against supply side economics). As you correctly say, this could equally have been a bond market reaction to a Labour party manifesto committing to large sudden and unfounded hikes in state spending on health & education etc. The bigger question perhaps is how the debt problem can be resolved, short med and long term. As every money printing exercise in recent years just loads more debts which young people are going have to pay back. We have to ask: is fake prosperity (printing money leading to rampant inflation and more debt) any better than austerity – morally and in terms of the real consequences for the young and working classes?