Letter to Eddie George March 2001

Written by Austin Mitchell

01 March 2001

Dear Eddie Our advice to the MPC is to follow through on the process it belatedly began last month. Reduce interest rates by 1.75% rather than leaving the UK, as it now is, sitting out on a limb with higher rates than other advanced economies, very high real rates, and an inflation target which is consistently undershot your target. High rates have compounded and sustained the long-standing British problem of interest and exchange rate overkill. Bring interest rates below Europe’s and the US so that Sterling comes down to a more reasonable level.   The chickens bred in the long period of overvaluation are now coming home to roost. Firms which have struggled to keep market share to keep going are running out of cash. Multi-nationals with plants in Britain and elsewhere are closing British plants to concentrate on more profitable alternatives. This is hitting the headlines in steel and cars but is paralleled in textiles, chemicals, engineering, even food production. It will gather pace unless some prospect of early, and sustained, competitiveness is held out.     We are uncompetitive in Europe, as the trade gap indicates. No use blaming this on the manifest inadequacy of the Euro, or hoping that some day it will perhaps go back to its launch levels. We must act for ourselves and the only way we can affect the exchange rate gap with Euroland which has produced such misery in farming and such job losses in manufacturing, is by getting the Pound down.   Far from being a cause for sustained self-congratulation, the fact that the inflation rate is so low (and lower than in Euroland, though our interest rates are higher) is an indication that we are now in a new period in which inflation will remain low for all the reasons we’ve set out earlier. Yet the MPC has continued to act as if it fears dead inflation more than loss of manufacturing, jobs and low growth. Its priorities are outdated.   Low inflation is also an indication that demand is deficient, and conditions too tight. Demand needs to be expanded. If this is done at the high exchange rate it benefits imports. The high exchange rate and the high interest rates mean under-running the economy and a low rate of growth. We need a higher level of growth to finance the government’s programme of higher public spending over the long term. We can get all this only by getting the Pound down. Substantially.   The British economy is slowing and needs to be boosted. The effects of any American slow-down will be greater on UK than on the rest of Europe, and compounded by the fact that the European alternative market is difficult and Far Eastern markets currently even more so. On all these accounts the economy needs boosting.   A reduction in interest rates now gets the Pound down. This is not only immediately necessary but gives the signal that competitiveness is the aim. The easy years of steady growth are over. This requires Government and the Bank to think ahead about long term prospects. Under its present inflation rubric the Bank is restricted in what it can do but it should also be aware that only faster growth can stimulate higher productivity and bring down unit costs, the only long term ways to lower inflation.   Government has to take into account the fact that if it genuinely intends to join the Euro then it can only do so at a much more competitive British exchange rate. It would be curious if Government and the Bank started managing the rate down for Euro entry after keeping it too high for too long to save manufacturing. The two needs, competitiveness and Euro entry, now point in the same direction - a lower exchange rate. Further rate reductions will be a signal to the markets that Bank and Government understand that prospect.   The Bank’s policies of high exchange rate and high interest rates favour the interests of Finance and penalise those of manufacturing. They also indicate a curious lack of confidence in the British economy. Why does the Bank still assume that we cannot expand at the rate of other competitors without a threat of inflation too great for us to face? Why is the growth rate in Ireland impossible here? Too much of the thinking of the MPC seems to us to be conditioned by instinctive, and out of date, reactions, all of which penalise the prospects of growth. It would help to generate a public debate on the real issues if the Bank’s thinking were made explicit on the crucial areas of NAIRU - does it exist and what is it: on the role of the exchange rate in inflation, on the causes of inflation and the relative roles of Finance and Industry in causing it, on the way and the time scale in which interest rates affect inflation and the rest of the economy. It is no contribution to genuine debate or public understanding of economic processes just to smile sagely and keep silent. Set out your beliefs and let’s check them against the record. We assume that with some members having supported a full half percent reduction last time the MPC will follow through this by another quarter point. We hope that the Committee will be aware that this is far from enough. The need is to stimulate the economy further and with inflation so very low the Bank has considerable room to do this. Why does it not do so?

 

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