February 7, 2023

By Hamish Mcrae, Financial Mail On Sunday
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Experiment: Chancellor Kwasi Kwarteng
This may just work, but my word it is going to be a hairy ride – and not just for the poor old pound. Kwasi Kwarteng’s emergency Budget kicks off a huge experiment with the economy in which we are all players. 
Conventional economics can’t really cope with this. It can look at the impact of a fiscal boost and conclude that the country might scramble through the winter without going into recession, or at least not a deep one. 
But it can’t tell us what happens when the sugar rush from tax cuts ends. It can’t tell us how people and businesses will behave. Crucially, it cannot tell us much about the costs of the inevitable surge in Government borrowings that will result. 
If the economic models don’t help, we have to rely on a sense of history and our intuition about financial markets to guide us. 
The history carries a couple of uncomfortable parallels, the Barber boom of the early 1970s and the Lawson boom of the late 1980s. Both ended in tears. The boost from Anthony Barber’s tax cuts in 1971 helped fuel the soaring inflation of the 1970s, while those of Nigel Lawson particularly from 1988 onwards were associated with the further burst of inflation at the end of that decade. 
Many of Lord Lawson’s measures, including the cut of the top rate of income tax to 40 per cent, have stood the test of time. So you could argue he was, ultimately, unlucky. But clearly Kwasi Kwarteng needs some luck now. 
The judgment of the financial markets matters for the simple reason that the budget deficit is going up, not down, and that means a huge increase of borrowing at rapidly rising interest rates. They have to stump up the money. There is a whirlwind racing through global bond markets right now and we are at the centre of it. You can see this most clearly in what has happened to the ten-year gilt yield. That is the benchmark for the Government’s funding costs, and it was below 1 per cent in January. At the beginning of August, it was still below 2 per cent. On Friday, it closed at 3.8 per cent. I expect it will go well above 4 per cent in the coming weeks. This is stunning and it affects us all. 
It is true that this is a global phenomenon as rates have shot up everywhere. But, whereas, until this week, the equivalent interest rate on US government debt was higher than that of the UK, now it is lower. And, of course, eventually, we have to pay the bill. 
So the package will have the effect of pushing up the costs of borrowing for all. The question then is what effect higher interest rates will have on the economy, and the most immediate impact there will be on the housing market. For those of us who remember paying double-digit interest rates on our mortgages, the idea of people having to pay, say 6 per cent or 7 per cent, might not seem too bad. But debt levels are much higher now than then, and rising mortgage rates come on top of higher energy costs. I don’t want to predict a housing crash and I don’t think that is inevitable by any means.
But it will be a more sombre period for the housing market and while stability there would be welcome, I worry that people who have overextended themselves will have a tough time. 
The greatest imponderable of all, however, is whether the combination of tax cuts and looser regulations can really lift the economy long term. Will businesses really invest more because they aren’t being clobbered by higher corporation tax? Will the City get more business because of the end to curbs on bonuses? Actually those limits were more of a nuisance than anything else, in that banks had to increase base salaries. 
And that top rate of income tax, now back down to that set by Nigel Lawson all those years ago? Maybe that will increase tax revenues rather than cut them. But we don’t know. As for the enterprise zones, there is some evidence that they create more activity overall, but also some signs that they divert business that would have happened anyway from elsewhere. 
My instinct is that this is worth a shot, even if the foreign exchanges have kicked the pound even deeper into the mud. The increase in Government borrowing is acceptable, though I hope that come the full Budget in November, we will get a clear path for getting it back to sustainable levels. Whether there will be enough progress in the next two years to convince voters is a tough one. But whether we like it or not, this is an experiment we’re all in together.
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