What the US Can Learn from the Fall of Liz Truss

We're even less ready than Britain for a conversation about fiscal austerity.

Dear readers,

Liz Truss’s term as UK prime minister and head of the Conservative Party did not outlast the head of lettuce.¹ Her economic plan of unfunded tax cuts and uncapped energy subsidies — and the market turmoil its announcement caused — ended up making her so unpopular that she lost her grip on her party, endured a string of only-somewhat-related embarrassments, and ultimately decided she needed to resign.

On the day that Liz Truss resigns after only 45 days, as the shortest-ever serving British Prime Minister in history, betting odds on her successor are taken in Westminster, on 20th October 2022, in London, England. (Photo by Richard Baker / In Pictures via Getty Images)

A remarkable thing is the role the financial markets played in bringing Truss down. Her policy could not stand, not because tax cuts for the rich were so reviled by the public, but because the market rendered such a swift verdict about her policy’s irresponsibility and its likely effects on inflation and central bank policy (which I wrote about here; I also wrote about her later partial reversal, which wasn’t enough to salvage her term). Her plan would mean more government borrowing, more inflation, and more interest rate hikes, and that translated almost instantly into a weaker pound and higher mortgage rates for ordinary Britons.

Basically, she was done in by the bond vigilantes — which is funny, because Republicans spent the whole Obama presidency waiting for the bond vigilantes who never came.

Obama’s massive budget deficits were “supposed” to spark spiraling inflation, market fears of government debt default, and painfully higher interest rates. That didn’t happen. As it turned out, the budget deficits were not actually inappropriately massive — huge deficits did not cause excessive economic stimulus because the economy was so depressed and there was plenty of slack capacity to absorb the added spending caused by all that government borrowing.

Of course, that’s not the situation today. As House Majority Whip James Clyburn admitted on MSNBC today, if the government spends more, that’s simply going to be inflationary in these conditions. It’s similarly inflationary if the government cuts taxes, or if it does things like forgive hundreds of billions of dollars in student loan debt. And when the government imposes inflationary fiscal policy in this environment, it makes the Fed’s job harder and increases the extent to which they’ll have to raise interest rates.

In theory, that should all show up in the bond market, just as it did in Britain. There are issues of scale — Truss’s plan was much more stimulative, relative to the size of the UK economy, than Biden’s student debt relief is relative to ours — but the whole incident has me wondering: What will US politicians do, if and when we get into a situation like Britain’s where fiscal policy is creating unacceptable upward pressure on interest rates, and deficit reduction is badly needed in order to bring rates down and keep borrowing affordable?

In Britain, they obviously needed to cancel Truss’s planned tax cut for high earners, and let a scheduled increase in corporate tax go into effect — and indeed the new Chancellor of the Exchequer, Jeremy Hunt, had already implemented a “U-turn” on those issues before Truss resigned. But they should also cancel some of the more popular parts of Truss’s reviled plan.

• They should restore a planned increase in National Insurance contributions (Britain’s equivalent of payroll tax) that Truss announced she would cancel.

• They should pare back her energy subsidies — this would both reduce fiscal stimulus and produce better incentives for Britons to conserve energy in light of the intentional supply shortage created by Russia.

• And they should look for other cuts on the spending side of the ledger. I don’t have a lot of granular opinions about British public spending, but this is the sort of macroeconomic environment where you might look for ways to contain the growth of benefits. Of course, Truss tried that — she floated a plan to tie increases in government benefits to wage growth instead of inflation, imposing a cut in real terms — and the idea was (unsurprisingly) widely despised.

Now let’s imagine some equivalent policy ideas to these, but in the American context.