Markets haven’t kicked out Truss. The Bank of England did.


The rapid downfall of the government of former British Prime Minister Liz Truss has been attributed to the objective discipline of financial markets. The logic goes, her misguided policies provoked a backlash that she had no choice but to back down and resign.

I see a very different story. Markets didn’t drive out Truss, as the Bank of England did – through poor financial regulation and very self-managing crises.

Truss won the leadership of the Conservative Party, which UK voters voted for power, by promising a set of deep tax cuts and increased government spending. Whatever one might think of her policies, it was her mission. I agree with many observers who have predicted that this will lead to higher inflation, higher interest rates, and potentially higher unemployment. But these adverse results take months and years to come to pass. Her government fell within weeks. How could this happen? (1)

Common wisdom is that financial markets “punished” the Truss government for its financial profligacy. But the discipline was far from universal. Over the three days that began on September 23, when the Truss government announced its mini-budget, the pound fell 2.2% relative to the euro, and the FTSE 100 index fell 2.2% – notable moves, but barely enough to bring the government to its knees.

The big change came in the price of UK 30-year government bonds, also known as government bonds, which saw a sudden drop of 23%. Most of this decline had nothing to do with rational investors revising their beliefs about the UK’s long-term prospects. Rather, it stemmed from the failure of financial regulators to limit leverage in UK pension funds. These funds bought long-term bonds with borrowed money and entered into derivative contracts with the same effect – deals that generated huge security demands when prices fell and yields rose. To raise the necessary funds, they had to sell more gold bonds, creating a cycle of doom where lower prices and forced selling double each other.

The Bank of England, as the entity responsible for overseeing the financial system, bears at least part of the blame for this disaster. As a result of its regulatory failure, it was forced to emergency intervention, buying gold bonds to set a minimum price. But it refused to extend its support beyond October 14 – even though its purchases of long-term government bonds have been fully offset by the Treasury. It is difficult to see how this decision aligns with the central bank’s financial stability mandate, and it is easy to see how it contributed to the government’s demise.

The way the Truss government collapsed should concern everyone who supports democracy. The Prime Minister was trying to fulfill her election promises. It has been frustrated not by markets, but by a loophole in financial regulation – a gap the Bank of England has proven strangely unwilling to fill.

More from Bloomberg Opinion:

• Sunak’s “dull returns” may not last long: Editorial

What Rishi Sunak brought to the Conservative Party chaos: Adrian Wooldridge

The Bank of England is a crash test dummy for central banks: Marcus Ashworth

(1) I thank, without getting bogged down, my colleague at the University of Rochester Christopher Slate for a helpful conversation.

This column does not necessarily reflect the opinion of the editorial staff or Bloomberg LP and its owners.

Narayana Kocherlakota is a columnist for Bloomberg. He is professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.

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