UK budget deserved ‘kick in the pants’, says former IMF economist Raghuram Rajan

Former IMF chief economist Raghuram Rajan says UK’s biggest tax cuts since 1972, which have crushed the pound, border on ‘irresponsible policy’.

Former IMF chief economist Raghuram Rajan says the Truss government’s budget in the midst of current inflationary pressures has been like “pouring oil on a fire”. Picture: Mandel Ngan

The top economist who ruffled feathers warning of the Global Financial Crisis ahead of time, former IMF chief economist Raghuram Rajan, said the UK deserved a “kick in the pants” for a budget that’s crashed the pound and pushed up London’s borrowing costs beyond Greece’s.

Dr Rajan, now professor of economics at the University of Chicago, said the UK’s controversial budget last week, which dragged the pound down to its lowest level against the US dollar since 1985, was irresponsible and undermined the UK’s credibility in financial markets.

“It was pouring oil on a fire essentially, cutting revenue and increasing deficit spending at a time when inflation is already so high, markets justly gave UK policy makers a kick in the pants,” he told The Australian in an interview.

The newly installed Truss government shocked financial markets when it handed down its first budget on Friday, unveiling massive tax cuts, including abolishing the top marginal tax rate, after earlier flagging a plan to cap UK households’ energy costs at an estimated total cost of 60 billion pounds.

The biggest UK tax cuts since 1972 as a share of the economy, worth an estimated 45 billion pounds over five years, were “bordering on irresponsible policy, at a time when you have such great concerns about inflation, and the central bank is raising rates as quickly as it thinks reasonable,” Dr Rajan said.

The Bank of England on Wednesday (Thursday AEST) said it had begun buying UK governments bonds “at whatever scale was necessary” to cut yields, which had surged 1.2 percentage points to 4.6 per cent for the nation’s 10-year bond, the highest level in 14 years.

“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability,” the Bank said in a statement.

Britain's Prime Minister Liz Truss is facing criticism from various quarters for her new budget. Picture: Dylan Martinez/AFP

Dr Rajan, who was governor of the Reserve Bank of his native India for three years until 2016, said the UK had learned it “didn’t have infinite credibility with financial markets”.

“Targeted spending to alleviate the plight of most affected households makes sense, you don’t want people to freeze, but an across the board give away even to wealthy sounds more like politics … a chunk of change to our constituents,” he said.

His remarks also came after the International Monetary Fund on Tuesday slammed the UK’s budget in an unscheduled statement saying it “understood” the UK wanted to help families and businesses “deal with the energy shock” and boost growth but “did not recommend large and untargeted fiscal packages at this juncture”.

The UK’s gross public debt to GDP ratio has surged from 83 per cent in 2019 to more than 100 per cent as a result of policies to ameliorate a series of Covid-19 lockdowns.

Before the Bank of England intervened on Wednesday, the yield on 5-year UK government bonds had jumped to 4.6 per cent, above the equivalent yield for Italy (4 per cent) and Greece (4.1 per cent), as investors factored in a higher chance the UK will ultimately default.

Dr Rajan famously warned in 2005 the financial system was becoming excessively leveraged especially in the US housing market, earning him the ire of then Federal Reserve chairman Alan Greenspan and former US Treasury secretary Larry Summers, who called him a “Luddite”.

“This is the old Reaganomics redux, I think that’s wishful thinking,” Dr Rajan told The Australian, referring to former US president Reagan’s massive US tax cuts in the early 1980s, which rather than boost revenue as expected, supercharged US federal debt and deficits.

The UK pound has fallen almost 20 per cent so far against the US dollar this year, trading at a value of around $US1.08 on Wednesday, after dropping as low as US$1.035 last week.

The remainder of The Australian’s interview with Dr Rajan will appear in Saturday’s The Australian.