Lucky Liz? Wait a few years to find out

Britain’s new PM, Liz Truss, might have caught a break last night.

The International Monetary Fund, after a longish period of complaisance in regard to fiscal stimulus, abruptly decided that the Truss economic plan was a good point to draw a line, in part because giving people their money back was seen as untargeted and might increase inequality.  

But in being so unusually prompt and decisive, it has missed a chance to wait and see which way the wind blows.

Because as our favourite Tyler Cowen points out:

“People think there is much more “stimulus” in the new plan than there really is.”

Meaning serious people (presumably including the IMF).

As Tyler explains, the planned energy subsidies are “expenditure” but not “stimulus”, because what they are doing is transfer “higher energy cost from the private sector to the public sector”.  

Because the expenditure is offsetting a known contractionary price shock, it is not “stimulus per se”.  (Cast your mind back to some of those technical Covid stimulus debates.)

His argument for why the tax cuts are (mostly) not stimulus is based on the likelihood that they will be saved.

The takeaway should be that the level of fiscal stimulus is probably not really the issue.  It’s much more likely to be the overall policy settings needed to navigate a tricky and painful economic adjustment for the economies emerging from the policy distortions and inflated expectations of the Covid years. (One could even stretch it to economies emerging from the post-financial crisis policy setting of government bailouts for everyone).

Politics aside, the IMF is conventionally bang on point when it says:

“Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy.” [Emphasis added].

Threading this needle is the challenge for policy makers.  Perhaps the frightening difficulty of the task explains some of the vehemence of Truss’s critics.

America, despite energy self sufficiency and high levels of market flexibility, is not finding it easy (and returning to a regular theme here, one might ask how much of this is due to the Biden administration’s poor regulatory policy).

Europe looks in even worse shape, with its energy deficit, financial imbalances between northern and southern states, and talk of another debt crisis after the election of a populist anti-EU government in Italy on Sunday.

Hedge fund manager Crispin Odey argues that Truss and her Chancellor Kwasi Kwarteng have chosen a lower taxes/higher interest rate combo as likely to minimise the depth of the coming recession.

In between having a whack at the anti-Brexit faction, he too thinks the key to sustaining above-average growth is reshaping regulation rather than fiscal stimulus:

“The Remainers would love it that our situation [to be] much worse for having left Europe. But actually in the last four years Germany has lent Southern Europe €400bn. That is a monstrous amount of money that will never get paid back.    

“Europe’s got all the same problems that [the UK has] in terms of inflation coming through, but it doesn’t have a Kwasi trying to sort of introduce a marketplace again… incentivising people to do the right thing rather than the wrong thing.”

His take on the government’s establishment critics:

“I don’t think it was politically motivated so much as it was, it was people [in the City] just hating that they might even get this right.”

A little extreme perhaps? But it shows Truss and Kwarteng have succeeded – perhaps beyond their wildest expectations – in establishing a clear line between themselves and the orthodox political establishment, pretty much everywhere that counts.

So if the UK’s economic performance over the next few years is any less dreadful than the rest, that could be decisive.

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