Oct 14, 2022 - Economy

Why Britain's economic mess matters even if you're not British

Former Chancellor of the Exchequer Kwasi Kwarteng

Now-former Chancellor of the Exchequer Kwasi Kwarteng. Photo: Carlos Jasso/Bloomberg via Getty Images

British Chancellor of the Exchequer Kwasi Kwarteng was fired on Friday as the government backed off of the tax-cutting plans he championed. The plan sent bond and currency markets reeling in recent weeks.

Why it matters: Britain's economic problems are unique in many ways. But recent events indicate that the world economy is entering a new phase, where deficits matter more and high inflation acts as a constraint on governments.

  • Moreover, financial markets are unusually jumpy, making for a volatile time in sovereign bond markets.
  • And the question of how independent major central banks really are — meaning how much economic pain they can or will inflict to bring inflation down before politicians take charge — is coming into question.

The backdrop: Every fall in Washington, the International Monetary Fund and World Bank hold annual gatherings of the world's financial elite. Some years feature one country that is in an economic predicament so serious, and so messy, that it dominates hallway conversations.

  • Think Greece in 2010, the U.S. in 2008 or Argentina in 2002. If you are a finance minister, your basic goal is to make sure your country is not that country. The United Kingdom has failed this test spectacularly.

Kwarteng was in Washington but skipped out on Thursday's Group of 20 finance ministers meeting. By Friday, he was back in London, his five-week run as chancellor having ended prematurely.

  • Prime Minister Liz Truss, herself very much in the hot seat, is being forced to back away from her signature policy of cutting taxes on the affluent after it triggered a selloff in U.K. government bonds and a steep drop in the pound.

Between the lines: The United States is in a stronger position than Britain. The U.K. is more reliant on imported energy, doesn't provide the world's reserve currency, and is working through the disruption of Brexit.

Yes, but: The events in Britain are a sign that the era of the free lunch is over. In the last 15 years, rich countries could enact fiscal stimulus, cut taxes, and massively replace lost income without worrying too much about inflation, or spiking interest rates.

  • It is becoming clear that we're now in a world with more explicit tradeoffs. The new British government was moving forward in that old framework, and markets are forcing them to rethink.

The bottom line: The omnishambles in Britain is quite a story to watch if you're an American student of economic policy. But just because it's happening an ocean away doesn't mean there are no implications on the homefront.

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