Sir Tom Scholar’s removal as the Treasury’s top mandarin was a brutal statement of intent by Liz Truss’s new government. The message was clear: the days when Britain’s economic strategy would be determined by bean counters were over. From now on, growth rather than balancing the books would be the priority.
That is the theory. In practice, removing what Truss sees as the “dead hand” of Treasury orthodoxy from the running of the economy is likely to prove difficult. The fact that all four deputy governors of the Bank of England are Treasury old boys is an example of its influence on the economic policy-making machinery. There have been attempts in the past to cut Whitehall’s most powerful department down to size. Sooner or later, all have failed.
What does ‘Treasury orthodoxy’ mean?
It was Sir Winston Churchill who first defined the Treasury view of the world. In his 1929 budget speech, Churchill said budget deficits came at a price, because the state has to pay interest on the money it borrows and the more it borrows the higher the interest rate.
As the cost of borrowing rises, businesses postpone expansion plans, so any boost from higher public spending is offset by the “crowding out” of private investment. In the classic Treasury view of the world, expansionary fiscal policy (tax cuts or spending increases) has no impact on growth or employment.
Attacks on “Treasury orthodoxy” are nothing new. John Maynard Keynes argued in the inter-war years that spending on job creation schemes would pay for itself because shorter dole queues would mean higher tax receipts and a smaller welfare bill.
More recently, the supposed link between big budget deficits and higher market interest rates has been broken. The UK borrowed huge sums of money in both the financial crisis of 2008-09 and the global pandemic from 2020 onwards, but the interest rate (or yield) on government bonds remains low.
Nor did attempts to reduce the budget deficit during the austerity years of the 2010s lead to faster growth. On the contrary, the UK’s trend rate of growth has fallen from 2.5% a year before the global financial crisis to at best 1.5% today.
What are Liz Truss and Kwasi Kwarteng changing?
Truss and her chancellor, Kwasi Kwarteng, say Treasury “orthodoxy” explains why the economy has performed sluggishly since the financial crisis of 2007-09 and so a different approach is needed. According to them, tax cuts will help boost activity. They say expansionary fiscal policy and supply-side reforms will raise the economy’s annual trend rate of growth back to 2.5%.
This will be easier said than done. Increasing the economy’s trend growth rate by even 0.5 percentage points would be a huge achievement, requiring radical action to cure some of Britain’s long-term problems: weak investment and poor skills high among them.
Moreover, Truss is not the first prime minister to see the Treasury as an impediment to faster growth. In the 1960s, Harold Wilson set up an entirely new ministry – the Department of Economic Affairs – as a way of circumventing Treasury caution. The DEA was wound up before the decade’s end.
Other countries – such as Germany – have separate finance and economic ministries, but Truss and Kwarteng seem intent on changing the Treasury from within rather than breaking it up. The chancellor has told his officials they are part of an excellent finance ministry but now needed to focus “entirely on growth”.
What’s happening next?
Scholar’s hasty departure was the first example of the new thinking but next week’s “fiscal event” fleshing out the government’s energy price cap plan and announcing details of Truss’s promised tax cuts will be more significant. This will be a real break with Treasury orthodoxy, although it remains to be seen whether the break will be temporary or permanent.
According to the Treasury view of the world, Truss’s go-for-growth approach represents a colossal gamble, but if officials have misgivings about the prime minister’s strategy they will keep their doubts to themselves and wait for an opportune moment to reassert the benefits of fiscal discipline.
Wilson’s Whitehall shake-up was scuppered by a sterling crisis and with the pound not far away from one-to-one parity against the US dollar, Truss’s plan could easily suffer the same fate.