Richard Portes - IMF Intervention “highly unusual”

The International Monetary Fund (IMF) has urged UK Prime Minister Liz Truss to reverse the decision to abolish the top rate of income tax. In a highly unusual attack on the economic policy of a G7 country, the IMF urged UK Chancellor Kwasi Kwarteng to use his fiscal plan in November to change course, warning that the fiscal stimulus risked undermining the Bank of England’s efforts to curb inflation.

London Business School’s Richard Portes appeared on Times Radio on Tuesday September 28th to discuss the comments made by the IMF, making the point that it was an extremely rare intervention by the IMF to level such comments at a developed country’s economic policy.

Times Radio’s Business News Editor Dominic O’Connell introduced his interview with Professor Portes by saying that there were was not much consensus among economists concerning the government’s mini-budget, adding that you can find voices that are in favour of pro-growth economic policies, but what has “rattled” many economists is not just the fall in the pound but the rapid rise of government borrowing costs which indicates that international investors are dumping UK government loans.

O’Connell asked Professor Portes how unusual is it for the IMF to rebuke a G7 government. Professor Portes said the Fund has taken a very unusual step in levelling such a strong criticism at the UK government and the government’s policies. “It is not something you would expect them to do with a country like China or even Germany, or the European Central Bank’s policies. That gives an indication of our influence, and certainly a representative for the Fund, someone representing the Treasury, would have protested [this intervention], but to no avail. So this is highly unusual, and remember, fiscal policy is the IMF’s specialty. It used to be said that the IMF stood for, ‘It’s Mostly Fiscal’, and so this is really an exceptional warning. It’s a warning against both the redistribution aspects of these policies and perhaps more importantly for more immediate concerns it is a warning that fiscal policies are acting at cross purposes to monetary policy, and that’s going to mean that the Bank of England is going to have to react.”

Times Radio’s O’Connell then turned to gilt yields and the increase in gilt yields, or the fall in gilt prices in inverse relationship, asking Professor Portes, “What is a gilt and why does it matter if the price of a gilt goes up?”

Professor Portes said that a gilt is the government bonds that are used to finance a deficit in the government accounts if one doesn’t raise taxes when one raises expenditures. “In fact the UK government is doing both – reducing taxes and raising expenditures. So one needs to issue more of these bonds (gilts) and if the prices of those gilts fall, as they have very sharply, then you have to issue more of them and the cost that one is paying, the yield on those bonds, goes up and that raises the fiscal deficit even further and that’s the kind of spiral that emerging market countries get caught in. It is also the kind of spiral that the UK government got caught in back in 1992 and 1976.”

O’Connell observed that there is a possibility that the Bank of England might hold an emergency meeting ahead of its next scheduled meeting on November 3rd “Would they contemplate a [further] interest rate rise, and if they did, why would they do it?”

“If they did,” commented Professor Portes, “it would be perhaps counter-productive and I believe that is one of the reasons why they won’t be holding an emergency meeting [in other words] trying not to show signs of panic. If they were to do that the market reaction might actually be negative. I think therefore that the Bank of England is trying to keep its nerve and keep in control of the situation. It is fairly clear that in terms of the markets they are not in control of the situation. Not only have the yields in gilts gone up, the cost of borrowing has gone up and the exchange rate has gone down very sharply.”

Setting the recent mini budget in a wider context, Professor Portes said that it was “funny” how the ideologically driven and motivated manoeuvres by the UK chancellor have been greeted by the global markets. “Ideology is a funny thing. The ideology of this government is very market orientated. The markets usually have it right and the funny thing is that the markets are telling them [the UK government] that they don’t have it right. The UK government response is that, “oh, we can ignore that – that’s very odd”.

Breaking news: In later development on September 28th US Treasury Secretary Janet Yellen has said that the United States was monitoring developments in Britain after the government unveiled a fiscal programme that sent the pound to a record low against the dollar, see Yellen says 'monitoring' UK developments after pound plummets.

Later on the 28th, the Bank of England took emergency action to stem a crisis in government debt markets, suspending its programme to sell gilts and instead pledging to buy long-dated bonds.

The central bank warned of a “material risk to UK financial stability” if the turmoil in the UK government bond market continued. It also raised the prospect of a “tightening of financing conditions and a reduction of the flow of credit to the real economy”. See, BoE warns of risk to UK financial stability as it intervenes in gilt market.