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Dear Eddie
Public speculation is more febrile then the settled stolidities of bankers so it’s not surprising that over the last month expectations have swung from a feeling of British exceptionalism, "look we have come through", to gathering gloom and a feeling that the world wind down is dragging Britain down with it. Our guess is that this mood swing will strengthen the Bank in its "wait and see" policy which has already put it out on a limb.
We assume that it will once again attempt to maintain confidence, particularly its own, by the usual policy of doing nothing, standing unshook amidst a bursting world.
Our assessment, however, is that the Bank is being left behind by the situation. It should fulfil its responsibility to act. along with the rest of the world, and particularly the US, to boost the British economy. That requires an immediate interest rate reduction of one percent to be followed by a further one per cent before October, the usual month for currency problems. These reductions should be part of a deliberate and announced strategy of getting the pound down while pointing out that the Bank will not resist a fall in the pound to more competitive levels and does not anticipate inflationary consequences from either. The Bank does not take account of one off increases such as the oil price. It should not, therefore, take account of a one off adjustment back to competitiveness.
We urge this strategy for the following reasons:
1. Markets will clearly not bring the pound down to a competitive level. It will therefore have to be managed and helped to a target rate particularly one proclaimed against the Euro and substantially lower than the present crippling level.
2. There has been a persistent effort to deny that overvaluation will do the same damage as it did in the two last great bouts of 1979-82 and 1989-92 but its consequences are inevitable and are now coming through. Manufacturing which still provides 20% of GDP and 60% of our exports and acts as a major driver for the rest of the economy is suffering badly and shedding jobs quickly now that the light at the end of the tunnel is so dim.
3. Consumer demand points the other way but is more superficial. It is temporarily boosted by credit and house price rises but readily satisfied by imports and hardly likely, therefore, to lead to inflation by boosts in domestic production.
4. The Chancellor is telling the world to act against recession. That certainly implies reduction of interest rates. Yet ours remain higher than Europe the US or Japan.
5. These high interest rates are blocking the operation of markets. The exchange rate is a market clearing mechanism, and competitive only when it clears markets and balances our trade in conditions of growth and full employment. It cannot now do this because high interest rates prop it up at an unrealistic level. In such a situation a balance of trade deficit on our growing scale would normally bring the points down but can’t with such high interest rates and there is a widespread feeling that even if it did the Bank would put up interest rates. To overrule such a correction would not only be wrong but takes us back into the old trap of supporting artificially high exchange rates and depressing the whole economy in the process. This would be as daft as it is unnecessary. Past experience shows that while devaluation from untenably high levels boosts the economy it does not produce high inflation.
6. Our trading relationship with Europe is being badly distorted. We cannot compete effectively in an open single market if our interest rates and exchange rate make us less competitive than the rest because this encourages imports, penalises exports and diverts investment to Europe where it has better prospects of producing a profit than here. The Japanese car plants particularly have been diddled in coming to Britain. Their profits are appalling. This is no incentive to new investment here. British capital has been happy to seize the opportunity to invest overseas for higher return and the kind of appreciation its had in North America but it is hardly a fair deal for the incoming suckers who could have done much better in the Euro zone or Eastern Europe.
It is difficult to explain to business or the electorate why our real interest rates should be so much higher than those of the ECB when our inflation rate is so much lower. This also frustrates what must be government policy, if only because it is proclaimed so often, of joining the Euro. If there is such a goal it does make it necessary to manage interest rates to undercut Europe’s.
7. The Bank is required to play one club golfing as its only game. It would be more honest to avow this frankly without the ritual monthly pretence that other aspects are taken in account. In practice this concentration on inflation alone is comparable to trying to regulate the body temperature of a patient by cold compress when he has gangrene of both legs and is undergoing an operation to amputate both arms. Hardly the Bank’s fault yet we do have to point out that the inflation rate has always, and often substantially, undershot the target so
there has been much more lee-way to reduce rates and stimulate growth than the Bank has taken. This caution speaks volumes about the Banks real imperatives.
8. Inflation is now naturally low for all the reasons we have repeated in earlier letters. So the Banks policy of repressing it by overvaluation is overkill and needlessly damaging to manufacturing. It creates the possibility of a Doomsday mechanism damping any prospect of real growth because that is viewed as inflationary. We must re-iterate the Governor isn’t a governor damping the speed of the engine to keep it permanently low. He’s a facilitator.
We have tried ever since the Bank took over responsibility to convince you and the MPC about the need for growth. It’s been like throwing pebbles into stagnant pools. No response to eminently sensible views and little effect on policy which has consisted of marginal fiddles up and then down.
Now the economic golden weather is over and times are going to get tougher. So the Bank’s judgements are going to be more called into question. This creates a need that debate should be widened. The opportunities created by giving interest and exchange rate policy to the Bank to educate the wider public should now be extended. Mystical processes aren’t satisfactory in troubled times. So the Bank’s decision making processes should become more open and more contestable.
The evidence on which the MPC makes its monthly judgements should be published in advance then the reasons for the decision and the views of members and their reasons should be published immediately afterwards. To allow a genuinely open debate with the interests involved. Now that the going is getting rougher it is time for the Bank to open things up and explain what it is doing and why and what it can and can’t do.
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