Changes in the Economy and Market Environment as Seen in the Resignation of UK Prime Minister Truss

Until about a year or two ago, when there was almost no concern about inflation in the world, implementing expansionary fiscal policy to stimulate the economy did not cause any notable problems. Well, actually there were problems, but because inflation was low and interest rates were low, they did not manifest.

However, things seem different now.

UK Prime Minister Liz Truss announced her resignation just 44 days after taking office. The announcement of a large-scale tax cut plan caused bond yields to soar, the pound to plummet, and her approval ratings to drop sharply. Having lost her centripetal force, she became a very short-lived administration.

Leaving the background and political commentary to the media, I personally think there are three key points.

1. The tax-cut faction won the leadership election, but...

During the Conservative Party leadership election, while Prime Minister Truss was a proponent of fiscal expansion such as tax cuts, her rival, former Chancellor of the Exchequer Rishi Sunak, was a fiscal conservative concerned about inflation and rising interest rates. In the end, Prime Minister Truss, who supported economic stimulus, won, but the financial market's reaction at the time was limited (some point to the rise in bond yields and the fall of the pound at that time, but the rise in yields was mainly due to the BOE's interest rate hikes, and the fall of the pound was mainly due to the strong dollar and the European energy crisis).

2. The market's reaction to the large-scale tax cuts was severe

However, when a large-scale tax cut totaling 45 billion pounds—exceeding the 30 billion pounds promised in the manifesto—was announced, the bond market played its role as a vigilante for the first time in a long while, and bond yields soared (*they were called vigilantes because the bond market used to issue warnings against profligate fiscal policy by raising yields). And due to concerns about fiscal deterioration, the pound fell significantly.

3. The hardline stance of trying to push through also backfired

It seems that the OBR (Office for Budget Responsibility) was not asked to prepare a revised economic outlook when the large-scale tax cuts were announced. Normally, the impact of policies should be analyzed in advance. Furthermore, even when the financial market reacted with rising bond yields and a falling pound, the refusal to communicate with the market and the public, and the insistence on a bullish stance, led to a significant drop in approval ratings. (*The OBR was established in 2010, and I remember being surprised when Alan Budd, whom I frequently met with as a former MPC member at the time, was appointed as the first chairman.)

These three points seem to be something that other countries, including Japan, need to fully consider when thinking about economic policy.