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Dear Eddie
Our concerns centre on the real economy of production and employment. So our recommendations to the Monetary Policy Committee this month are the same as in previous months: reduce interest rates substantially.
While inflation is both low by historic standards and unthreatening, unemployment is high by the same standards, as are real interest rates. That combination is unacceptable when resources are under-used, demand inadequate with far too much of it channelled to imports rather than domestic production. For the third time in just over two decades, Britain’s manufacturing base, already smaller than most, is shrinking rapidly. The TUC’s recent study shows substantial job-shedding already. Much more threatens in the car industry, engineering generally, and textiles and garments.
When manufacturers point out that they cannot increase productivity or cut costs sufficiently to stay competitive they are really saying that the Pound is too high making our costs, translated into foreign currencies, too high. This is not just against the Euro for our trade deficit with the rest of the world is deteriorating more than that with Euroland, indicating to us that the Bank’s standard claim that the Pound is overvalued mainly because the Euro is so low, is not correct.
The Bank’s high interest rate policy is misguided when our rates and exchange rate are both so much higher than the rest of the single market in which we compete. Consumer demand is kept up by excess credit, by increases in government spending and the "wealth effect" of high house and stock market prices. This makes today’s situation very similar to that of 1989 and probably a similar prelude to recession. If the same sequence of events follows now, and we do not see what is to stop it, then the Bank must be considered largely responsible. The fall in the Pound which alone can now improve matters for the production economy is unlikely, would in any case take time to make its effects felt and will, given the Bank’s approach, have to be counteracted by still higher interest rates, rather than the reductions which followed the fall in the Pound after our departure from the ERM creating the recovery which then began. By keeping interest rates so high in real, historic and competitive terms when inflation is so low the Bank has left itself no alternative but to administer more of the medicine which has made the patient sick in the first place.
Given that gloomy prognostication we see no alternative but to reduce interest rates along the lines we have so continuously urged. We are alarmed to find expectations abroad that rates may, in fact, increase. On the same kind of assessments which have led to increases in the past they should rise now if the Bank is to be consistent. Yet if it does put them up with the economy slowing and the high Pound universally agreed to be ruinous, the Bank will be both damaged and discredited. Such is the stark choice you now face. As you do so we would ask the MPC to think seriously about the situation we are in by pondering its answers to questions which now arise.
- After nearly three years of rate fidgeting, a process which is expensive and causes uncertainty, why has inflation been so steady? What is your assessment of the effects of all the changes to interest rates on the inflation figure which is your lode star?
- Why has the inflation rate remained so consistently below your 2.5 target? The MPC seems to be opting for consistent overkill rather than growth. What effect has this gap between actual and target inflation had on growth? What would be the effect on growth of an equal variance on the higher side?
- Why does the MPC operate on the basis of an assumption that the British economy cannot sustain any higher level of growth than the inadequate figures averaged over, say, the last four years? Why can the Irish economy operate on the basis of a growth rate double or treble ours for a long period and does any damage produced by higher inflation there outweigh the substantial benefits and the higher productivity generated by much higher growth? The same questions arise with regard to both France and the United States.
- What account have you taken of house prices in the south east in deciding interest rates? Why should house prices, which do not feature in the target rate, play any part at all?
- Interest rate decisions appear to us and most of the country outside London to have been influenced far more by pressures in London and the south east such as large salary increases, bonuses in the City and the Finance sector, the general pressures of congestion and skill shortages in a capital which is a higher cost centre than any other capital city because so much bigger, as distinct from any consideration of the well-being of the rest of the country. There house prices are far lower and rising minimally, unemployment is still high and there are more older people looking for work but not counted as unemployed. The economy is being run in the interests of the Finance sector, strong in the south east and in your counsels and of the service sector rather than manufacturing which is on the front line of very intense world competition. How do you draw your balances between these two sectors? What part in drawing them is played by assessments of their relative contributions to employment and exports? Who on your committee, and in your advice stream, speaks for the one and who for the other?
- Since the Bank seems to work, at least in its homilies, on the principle that inflation is a tiger waiting to spring so that a stitch in time saves nine, what is your valuation of the extent to which inflation would rise with lower interest rates? The situation seems to us to have fundamentally changed since the Seventies and Eighties. The power of Labour is broken, the unions much weaker, business can’t now manage prices which are more transparent. Competition is more intense, government policy is reducing price differentials in Britain, bigger trading areas and single markets in Europe and North America bring economies of scale and greater competition. The world is awash with excess productive capacity, much of it still under-used with more coming on stream in China particularly, but also across the industrialising countries. All this means a permanently lower level of inflation. Yet that appears to play no part in the Bank’s calculations and attitudes.
- There is a clear problem with the exchange rate between Sterling and Euro. Euro-sceptics gloat at the Euro’s decline. The Bank blames it for problems of its own making. Yet what no-one seems to consider is that only European bankers are worried. For most Euro governments the Euro is doing exactly what they want it by giving European manufacturing a strong competitive advantage which it is exploiting to grow. Euro economies are picking up. Growth is increasing. Unemployment is falling. Competitiveness works - as we’ve told you many times. European governments can hardly be blamed for seeking their self-interest in this way. The real problem is why don’t we?
- Should you now consider dispelling the mystique which surrounds your role? We have urged policies on you which we see as being in the interests of the wider British economy. So have many others. The Bank has played up to this by regular expressions of regret at what it is doing to manufacturing, by holding out illusory hopes that the Pound will fall, or the Euro rise, or counselling patience: control inflation and all will be well. In fact, though, your remit on inflation really drives out all other considerations.
Now that your excessive concentration on the one objective of inflation is producing inevitable damage to the real economy we wonder whether you shouldn’t stop pretending to do something you can’t, and frankly avow that your one role and overriding responsibility is to keep inflation close to 2.5% by using the one blunt instrument of interest rates. This will amount to saying that you are using overvaluation to defeat inflation but it’s better to be honest.
Inflation has indeed been kept down but at the cost of real damage to the real economy. Now that the damage is reaching a crunch point that there is nothing you seem prepared to do except wait for the Euro to go up. You have only done your job under the terms imposed on you so the responsibility lies with government not you. Would not such a clear avowal clear the air and make responsibility absolutely clear? |
