The true cost of Liz Truss’ power plan is staggering

In October 2008, a financial analyst at JP Morgan wrote an article in the New statesman with the title: “And yet the chancellor borrows”. In it, he lamented the “insaneness” of an increasingly unpopular party trying to stay in government by brushing aside “fiscal responsibility” by dramatically increasing government debt, only to leave it in the hands of an immoral industry. “We like to believe in markets in good times. When times are bad we run to the state,” he wrote.

The author, of course, was Kwasi Kwarteng, who is now Chancellor himself and is doing exactly the same thing in the same position. Last week, Liz Truss announced that the government would cap consumer energy bills to £2,500 a year for a typical household for two years and offer a similar rebate to businesses for six months.

This plan provides an important and very significant reduction in energy costs, and the government expects it to reduce inflation by up to four to five percentage points as a result. However, this is a short-term effect that is associated with immense costs in the long term. It obliges the UK to borrow an unknown and unlimited amount from the financial markets at an elevated interest rate in a way that will result in higher inflation and interest rates for years to come.

The effects of this can already be seen in the financial markets, where inflation-linked securities change price depending on how much inflation will rise or fall by the people buying and selling them.

“Longer-term inflation expectations have not come down much,” said Janet Mui, Brewin Dolphin’s head of market analysis. “The market thinks inflation is coming in a year [in the UK] will fall, but five to ten years from now, inflation is expected to remain high. So the lower inflation compared to previous forecasts is a very short-term thing that the market is anticipating due to artificially depressed prices, and indeed the market is concerned about the longer-term impact of inflation.”

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Part of this concern stems from the fact that the energy price cap, as it will be paid for by new government bonds rather than new taxes (e.g. windfall tax), obliges the UK to borrow as much as needed. The cost of the plan has been estimated at £100bn by the Government and £250bn by others, but the truth is that the UK will have to pay the difference between wholesale energy costs and the new price cap. As wholesale prices can increase exponentially, as we have seen, UK borrowing is virtually unlimited.

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However, it gets worse because sovereign debt – when it is taken up by the financial markets – is not all created equally. Commitment to borrowing a practically unlimited amount from the financial markets means commitment to sell a practically unlimited number of government bonds or government bonds. That makes these gilts cheaper. As bonds become cheaper, their “yield” (the return received by the lender) increases. The UK’s new borrowing to finance the energy ceiling will be issued at current market levels, which Mui believes will make the country’s new borrowing costs “very high”.

But this is not the only financial market where the UK has to pay more. Rising debt and a large trade deficit are affecting the value of the pound – now at a 37-year low – making imports more expensive and pushing up prices across the economy. It’s an effect we’ve seen before: Researchers at the London School of Economics found that the post-Brexit pound’s fall in sterling pushed up UK inflation by 1.7 percentage points.

Even more of a cost comes from the fact that the Truss plan not only weakens market confidence in the UK, but also fails to address the demand problem.

Stephen Millard, associate director of macroeconomic modeling and forecasting at the National Institute for Economic and Social Research, explained that “somebody’s going to have to pay energy companies to cover their costs.” If the government takes on new debt to pay the bill, he continued, “more money will flow into the economy … there will be more demand for goods and services throughout the economy … and that increase in demand means that… inflation will be higher”.

Millard said this will leave the Bank of England with little choice but to counter the government-created demand. “The government spends a lot more money, which creates additional demand … which drives up inflation. At the same time, the Bank of England tells us: “We still want to bring inflation back on target. So we need to be more responsive by curbing that demand to bring inflation down.’”

Using a blunt instrument – ​​the same benefit to everyone in the country – also fails to meet the energy demands of businesses and consumers. While France is discussing energy rationing and German banks are turning off their heating in a global supply crisis, Great Britain is giving its wealthy citizens and companies no incentive to limit their energy consumption.

“If anything, the incentive is to actually use too much gas,” Millard said, “because you’re paying for it well below the odds. And then the concern is that this will actually lead to a deficiency.”

The new energy from fracking and new nuclear power plants will come – if at all – in a decade. The only short-term measure the UK now has to address the wholesale cost of energy is to reduce demand for it by insulating people’s homes, making businesses more energy efficient and incentivising those who can afford it will use less. With such an incentive, many could invest in energy saving measures; without them they will wait and see.

In essence, the Truss Plan amounts to a quarter of a trillion pounds being spent pretending that the past decade of energy policy has not been a short-sighted and wasteful disaster and that the recession we all know is coming will happen to someone else. It may keep the economy looking healthier for a while – maybe just long enough to get through early elections – but the price of cheaper energy all winter will be a weaker economy for a decade.

[See also: Let’s not forget to scrutinise the new energy policy]

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