Why did the UK Truss administration fail? Does MMT not work?

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Now, let's get to the main topic.

The UK Truss administration withdrew just a month and a half after taking office.

The reason is that they became unable to manage the government soundly due to the failure of their economic policies.

What exactly was the failure of their economic policies?

The main campaign promises of the Truss administration were these.

• Large-scale tax cuts

• Subsidies as a countermeasure against soaring energy prices

Ms. Truss implemented her campaign promises immediately after taking office as Prime Minister.

However, as soon as this policy was announced, the British pound and UK government bonds plummeted!!

Pound-Dollar

UK 10-year bond price

Various media outlets explained the cause of this crash as 'fiscal anxiety regarding the UK government'.

Certainly, all the funding for policy implementation was to be covered by government bonds.

Against the backdrop of this market turmoil, the Truss administration faced fierce backlash from public opinion and within its own party, and was forced to resign after only a month and a half.

This is the full story of the Truss administration's withdrawal.

Looking at this, I had a few questions.

That is the point that the reason for the crash in government bonds and currency is 'fiscal anxiety regarding the UK government'.

This is because the UK has the right to issue currency, so there is no default risk for government bonds denominated in its own currency.

If government bonds were to crash due to fiscal anxiety, Japanese government bonds should have crashed long ago.

The following is the total government debt balance relative to GDP for Japan and the UK.

In other words, if we are talking about fiscal anxiety, Japan's fiscal situation is worse.

However, Japanese government bonds have not crashed.

Although the Japanese yen has weakened significantly due to rising US interest rates, there was no situation where the 'yen crashed' before the rise in US interest rates.

Therefore, 'fiscal anxiety' does not seem to be the reason for the crash in government bonds and currency.

So, what is the real cause of the crash in UK government bonds and the British pound?

I believe it is precisely the 'worsening of inflation'.

The following is the trend of the UK's core CPI year-on-year.

Like other countries around the world, the UK is currently suffering from high inflation.

In such a situation, if large-scale tax cuts and large-scale subsidies are introduced, inflation will accelerate even further.

However, this might raise the following question.

In the case of the US, worsening inflation induces interest rate hikes, leading to a historically rare strong dollar. Why does worsening inflation in the UK lead to a weak pound?

That is the question.

Indeed, why did worsening inflation lead to a weaker pound in the UK?

This is thought to be due to the difference in the stance on curbing inflation rates.

In the US, both the central bank and the Treasury are committed to curbing inflation.

Even in the US, a massive fiscal policy was enacted this summer, but it secured funding sources other than government bonds, such as tax increases, showing consideration for inflation.

On the other hand, the UK attempted to implement a massive fiscal policy without preparing funding sources under high inflation, which simply promotes inflation.

When high inflation continues, the currency value naturally falls.

In other words, the UK government declared to the market that it had no intention of protecting the currency value of the pound.

Therefore, a massive crash of the British pound occurred.

This is considered to be the cause of the crash in UK government bonds and the British pound.

So, what about Japan?

In Japan as well, the Ministry of Finance's austerity policy has recently been viewed as a problem, mainly by some opposition parties, and there are calls that tax cuts and expansion of fiscal spending are necessary for the revival of the Japanese economy!

This is because Japan has long experienced deflation and low inflation (below 1%). In other words, there was a deflationary gap where demand was insufficient.

In such a situation, currency value can be maintained even with fiscal spending.

However, even in Japan, the latest core-core CPI (for September 2022) reached +1.8%. It is now close to the 2% level targeted by the Bank of Japan.

Although the main cause is the rise in import prices due to the weak yen, if large-scale tax cuts or the like are implemented here to accelerate inflation, there is a possibility that Japan could follow in the UK's footsteps.

At such times, it seems necessary to handle fiscal policy with proper discipline. (However, I would like to see more fiscal expansion under deflation.)

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