What happened in the United Kingdom is a good example for Spain of what cannot be done in an energy crisis, with high inflation and very high public debt. A political crisis in which his own party forces Boris Johnson to resign. A very competitive primary process in which you need to be chosen by the militants. And promises of tax cuts to win by emulating the image of Margaret Thatcher, irresistible to her militants.
The problem comes when you win, you arrive at 10 Downing Street and a Treasury official tells you that there is no money in the box. The United Kingdom closed 2021 with a public deficit of 8% of GDP and public debt at 95% of GDP, double that of 2008, before the bankruptcy of Lehman Brothers, and that of 1979, when Margaret Thatcher came to Government .
Liz Truss had two options: tell her militants and Britons the truth or keep her campaign promises. And she opted for the second option.
His first decision was to approve a fiscal expansion plan that meant almost tripling the public deficit forecast announced by the previous government for this year. The tax cut was a third of the plan and the remaining two thirds was increased public spending. According to Rudiger Dornsbusch’s model, with rational expectations such a fiscal plan would cause more inflation, rate hikes from the Bank of England, make it more attractive to invest in pounds in the short term and cause an appreciation of the exchange rate.
The effect was the opposite. Investors panicked, stampeded and caused the pound sterling to crash with a virulence not seen since the crisis of the European Monetary System in 1992. That same day, the Bank of England issued a statement stating that after the approval of the stimulus plan fiscal maintained their inflation forecasts. Investors stopped believing in the British Government, in the Bank of England and fled from the pound to minimize losses causing the market to collapse.
The Bank of England, aware of its mistake and of the risk of provoking another financial crisis similar to that of 1992 or even like that of 2008, decided to intervene in the market with a massive purchase of public debt, failing to comply with its strategy and its mandate to reduce inflation. The bank had not only promised to stop buying debt, but also to reduce what it already had.
Liz Truss was forced yesterday to announce that she would not apply part of her fiscal expansion plan. The problem with monetary and fiscal credibility is that it takes a very short time to lose, but it may take a long time for investors to believe in the pound again and to give credit to the British Government.
The contagion of the pound crisis was devastating on the Italian public debt. The same thing that happened in 1992, but this time as Italy is in the euro, the indicator of investor fear is marked by the risk premium of its public debt. The effect is the same, since what caused the rise in the risk premium was a massive flight of capital that fled from Italian debt to take refuge in short-term public debt from Germany, the US and Japan, mainly. What caused the panic of investors to also flee Italy? That Giorgia Meloni had campaigned on the same populist promises as Liz Truss. With the addition that Italy is a country that has experienced negligible growth for many decades and its public debt is 150% of GDP, 50 points more than the British. Will Meloni tell the truth to Italians or will she keep her campaign promises? We will see.
The German government, anticipating the energy crisis that is upon them due to the Russian gas supply cut, has also announced subsidies to its citizens of energy prices equivalent to 5% of their GDP. Germany’s fiscal situation is better than Britain and Italy, with public debt expected this year to be close to 70% of GDP. But his fiscal expansion plan would mean more than doubling the deficit forecast announced to investors for this year. Germany has unilaterally blown up the European fiscal rules and that affects the credibility of the euro, will force the ECB to raise interest rates further and puts pressure on the Italian risk premium and that of the rest of the highly indebted countries .
Spain has frozen public spending in the first half of 2022 and that has allowed the deficit to be reduced by 30%, as confirmed by the INE last week. But we are also in the campaign and a tax reduction war has been activated that began in the Andalusian Government, continued with the Valencian Government and reached Moncloa announcing a deduction in personal income tax. At the moment, we are talking about quantities much lower than those of the United Kingdom, Italy and Germany. But investors are fearful and they are looking at our public debt close to 115% of GDP, our gross debt issuance of 17% of annual GDP, a structural deficit of some 50 billion euros, most of it concentrated in our public pension system, and with the commitment to increase it by around 15,000 million for the revaluation of pensions with the CPI.
With high inflation and the uncertainty of the gas crisis, the only thing missing was a financial crisis like the one that forced the Spanish government to ask for an international rescue in 2012. We hope that there is intelligent life to send reassuring messages to international investors and avoid it .
Jose Carlos Diez He is Director of the Orfin Chair at the University of Alcalá
