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Dear Eddie
Along with most commentators, the Labour Economic Policy Group was disappointed by the Bank`s failure to follow through on its earlier, very marginal, reduction of interest rates by a more substantial reduction last month.
The game is moving ahead of the Bank. Rather than anticipating events and managing monetary policy accordingly, the Bank is being relegated to its own banker`s ghetto of studied inertia, modified occasionally by belated, fiddling, changes which give the image of economic fidgeting carried on in the wake of events rather than a body, using its management tools to ensure low inflation, steady growth, and a healthy British economy.
Nor has the Bank lived up to the expectations it holds out from time to time. You declared some time ago that the Bank would act as firmly to correct inflation undershoots as it would with overshoots. In fact, inflation has consistently undershot which gives the Bank considerable leeway to expand the economy and reduce the interest rate. Yet it has done nothing. This creates the impression that the new regime is there to impose Banker and monetarist priorities on the economy rather than to tackle the long term problems which themselves have led to higher inflation in the past.
This obsession with the priorities of the financial sector which are elevated then over those of the production sector, is underpinned and confirmed by the old, discredited, and no longer relevant, policy principles on which the Bank appears to work. One is the obsessive fear of inflation ignoring the fact that it has obstinately refused to revive, despite the Bank`s regular warnings. Another is the acceptance that there is some kind of NIARU so that unemployment cannot fall below a certain level without inflation. A third, the belief that Britain is, somehow, more inflation prone than other countries, despite the fact that it has gone further in the direction of economic reform and market liberalisation than any other European economy. Finally, there is the patently false belief that any fall in the exchange rate must be prevented because of some assumed inflationary consequences.
All these outdated positions have combined to produce a policy of managerial inertia which requires British producers to compete in an increasingly tough world, and particularly in a Single European market with the odds loaded against them by a ball and chain of high interest rates and overvalued Sterling round each foot. This is then compounded by the competitive devaluation, accidental or deliberate, of the Euro. Yet the Bank in its wisdom has ignored their problems, shed only crocodile tears over the decline of manufacturing, the closures and loss of jobs in industries which have been kept powerful and competitive in other countries and done nothing about any of it. Beyond expecting production to somehow survive in the hostile economic climate it has created. This is more appropriate to an outward-bound course than competitive success. The Bank is widely and, in my view, rightly, felt to have no understanding of manufacturing or the dynamics of production.
The main area where the MPC has failed to fulfil its own expectations is on the exchange rate. Regular statements have agreed that it is overvalued, expressed hopes that it would somehow - no-one knows how - come down of its own accord, or that the Euro would rise through some mystical processes. The Bank has rejected all the proposals for intervention or managing the exchange rate down. So has the Government and there is no indication that either has given such proposals analysis or serious consideration.
The resulting economics are simple and inevitable. Overvaluation does check inflation now but only at the expense of increasing it later as unit costs rise, overheads press more heavily on shrinking production, productivity flags, and resources - whether of capital, plant or people - cease to contribute to public spending or growth and become a drain instead. Such are the long-term consequences if nothing is done.
The pious hopes extended by the Bank that markets would somehow remedy the situation on their own have shown no signs of materialising. The Pound remains obstinately high. Yet the obvious explanation that this is because our interest rates are higher than everyone else`s, and far higher than they should be for competitiveness is continuously ignored. Nothing is done about it, even though inertia in the ECB about reducing their rates (which may not survive the next meeting) and the rapidly falling rates (to be compounded by tax cuts) in the US both make it possible to act for ourselves to decouple from the Dollar and to pursue our own interests. Indeed, a co-operative effort to offset the looming prospect of world recession by co-ordinated expansionary policies for central banks points in the same direction and we should not stand aloof from it.
In the face of these pressures the Bank seems to fear that Britain can’t act for itself and shows neither feeling that we can influence our own exchange rate nor willingness to do so. This can only be because the Bank is eager to keep using the temporary benefits of overvaluation to keep inflation down, albeit at the expense of the long term damage to the British economy which it is prepared to ignore because it sees neither future nor role for manufacturing.
So the Bank stands "unshook amidst a bursting world" while America reduces rates, Japan takes them to zero, and the ECB maintains a lower rate which has already ensured a competitive devaluation despite the fact that inflation in the Euro zone at 2.6% is well above ours and above their target. Surely the Bank owes the country an explanation of why this is - particularly since the ECB say they want the Euro to go up while we clearly want, and need, the Pound down.
All this points to an obstinate inertia, which is deeply damaging to long term prospects for investment and growth in Britain. The signals sent out by the Bank and the MPC are that Sterling will be kept too high, the prospects of making a profit by producing in Britain will remain slim, and multi-nationals with more than one plant, considering what to close, where to invest, or where to set up, should all avoid this tight little, seldom right (or competitive) little island.
Given the priorities, polices and past performance of the Bank the prospects for Britain are slow growth, too small a productivity increase to absorb the upward pressure on prices, excessive unemployment, weak demand, a gaping trade deficit and long term competitive failure. Particularly in the European single market. This suggests the need for a fundamental re-consideration of the bases of policy.
Take all this together with the current statistics pointing to flagging growth, growing problems from the weaknesses of the American economy, and its failure to maintain its role as the importer of the last resort, the economic impact of Foot and Mouth and the loss of tourism, flagging demand, weaker consumer confidence and the tightness of advertising (always a useful leading indicator) and everything points to the need for a substantial reduction in interest rates this month to boost the economy before it’s too late. We must also play our part in a concerted effort to boost the world economy instead of lagging behind everyone. We therefore recommend a two per cent reduction as a signal and stimulus for a flagging economy which needs long term prospects of competitiveness. |
