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Dear Eddie
Your strategy this month is likely to be to play safe and maintain your high interest rates/high Pound policy. This would be a mistake leaving Britain dangerously exposed, and out on a limb compared to the stronger economies of Germany, Japan, France and the US, all of which have lower real interest rates.
You should reduce interest rates by two percent to bring the Pound down and ease the accumulating damage to manufacturing and production. Britain cannot survive in increasingly competitive markets if our producers have to run shackled.
The world economy and our British economy appear to be giving different signals. The world economy is slowing fast, possibly heading for recession if the American engine stalls. The British is growing slightly faster than the low rate of growth anticipated with consumer spending higher, though this is the usual lagged effect which comes at the end of every period of growth, however feeble.
This contrast may encourage you to play safe by holding rates or opting for one of your mini movements. Either would be wrong. The improvement in Britain is pathetic, largely financed by credit and the increase in government spending. Both will be insufficient to provide an anti-cyclical boost on the scale necessary. Both conceal a rapidly deteriorating situation in all facets of manufacturing, in the trade balance, in exports and in production generally. These could end the fall in unemployment and will be compounded by the deterioration of the world, and particularly the American economy. Our exports must be hit hardest because more overvalued. An uncompetitive Britain is more exposed.
So there is no justification for keeping real interest rates so high and no reason why ours are so much higher than competitors’ when our inflation rate is lower. Nor can keeping the Pound at this grossly overvalued level be justified. It is inflicting long term damage on the economy and the Bank cannot wash its hands on it. High real rates are a major influence in keeping Sterling at a level which, nearly everyone agrees, has been too high for far too long. Your responsibility, therefore, is to act now, to reduce rates, and the Pound, to anticipate events and do what you can at this late stage to ward off the worst consequences of the external difficulties and internal damage now accumulating from prolonged overvaluation.
The MPC has had a very easy time up to now. It will be harder from here on in. You will no longer be able to sit back and use high real interest rates and an overvalued exchange rate to damp the economy, maintain pressure on prices, keep imports cheap and fight inflation, however damaging all these processes are to manufacturing and the real economy of production for competitive markets by which the country lives. MPC policy has kept inflation down in much the same way as a speed governor on a car keeps MPG down and the gilt is taken off this modest achievement because inflation would have been low anyway, in a highly competitive world where the power of labour to force up wages and capital to impose prices are both broken. Thus the overall result has been to maintain "stability" where the economy needs higher growth and to give us low inflation when we need higher employment.
This is not a particularly successful record. Indeed, manufacturing output is not much higher than in the early Seventies, something true of no competitor. Yet it hasn’t produced the economic difficulties many (including ourselves) expected because the damage has been largely concealed: firms kept going without investment to keep markets, the trade gap was bridged by capital flowing in, credit was loose, keeping up purchasing power and though productivity improvement was low compared to the US, and almost anywhere else, the returns from our investments there helped compensate. Yet the end result is four years of under achievement, Britain lagging, more and more, behind the OECD game, and the throwing away of a window of opportunity to grow faster and trigger that cumulative improvement others once enjoyed.
Now the American slow-down and the stagnation of the world economy mean we can no longer be tugged along behind expanding US and European markets while not doing anything much to help ourselves. We are in a different game which puts the onus on the MPC to act as Tokyo and the Fed have. Otherwise we are out on a limb in a world where the FED has moved quickly and substantially to keep the economy going, Japan has done all it can and the ECB has moved a little and will almost certainly move more to revive growth.
Britain has done nothing. To persevere now with the high real interest rate=overvalued Sterling strategy, so long central to the MPC and the Bank, means that we run increasing risks. The Bank will be putting itself in direct confrontation with the accumulating market pressures on Sterling which arise from a faltering economy. Slow growth, low productivity, gaping balance of payments, falling capital inflows and flagging exports will all work to bring down Sterling. Yet the Bank’s every instinct will be to fight the fall because of its fear of inflation. This is unrealistic in today’s conditions. Yet the Bank is too deeply conditioned to it to give it up.
The proper strategy is to get ahead of the game by the substantial reduction of interest rates we have consistently advocated. Bring down Sterling. Revive the productive economy. Stimulate domestic demand, and particularly housing, by lower interest rates. Ease the balance of payments constraint which, as the IMF forecasts, is going to become a stranglehold. Move ahead of markets, anticipate the problems, and act for Britain rather than shifting uneasily from left buttock to right, which is the essence of Bank policy to date. |
