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Dear Eddie
The Labour Economic Policy Group does not believe that the Monetary Policy Committee will decide this week to increase interest rates. However, we stick to our strong view that it should reduce them. As you will know from our previous correspondence we think that the reduction should be substantial and that you can, and should, halve the current rate.
However, as realists we will welcome any reduction at all, even though any you opt for is likely to be too small for us and smaller than the economy needs, summat is better than nowt and owt will be a valuable signal to markets, and an indication that the Bank has at last accepted that low inflation and cheap money are here to stay. We won’t, therefore, go into any long explanations or arguments this month. We make only the following points.
(1) The pound remains substantially overvalued. It is far too high for manufacturing which is rapidly shrinking, shedding labour and transferring production we need to keep here to Eastern Europe, developing countries, anywhere which is cheaper. When call centres, the cheap labour centres of which we have more than any other country in Europe, are going east, it is time to accept that only a much lower pound can allow us to compete in anything. You have the responsibility to bring it down. You can do so by reducing rates as a signal to markets. The longer this is delayed the more damage is done.
(2) Much is made of the need to encourage inward investment. In fact, we don’t want big inflows or big buying of sterling. If we can’t penalise the inward flow, as both Germany and Japan once did in the past, we certainly shouldn’t reward it by paying rates higher than everyone else’s.
(3) The age of low inflation and low prices has arrived to the degree that several commentators are now asking whether we are heading for a deflation like the inter war period. We don’t think that. Yet we do see that inflation is no threat. Britain will enjoy low inflation whatever the interest rate you set. It is, therefore, sensible to reduce the price of money and keep it low by a sustained policy of cheap money. Interest rates are now little use as a regulator. So use them to stimulate the growth the nation needs. As do Labour’s spending plans. In such a climate with no real threat of inflation, interest rates have no where to go but down.
(4) The economy remains very fragile – probably more so than anyone admits. The Fed has kept rates low to stimulate the US engine for growth. There are weighty calls for a reduction in Europe where they are already lower than ours because of the weakness of the German economy. Our economy is in a superficially better position because of consumer demand, though that is now flagging, and even more because of Gordon Brown’s big (and very necessary) boost to public spending. You have the same responsibility to stimulate growth and demand as the Fed and the ECB and because manufacturing has suffered more the boost must be bigger if balance in the economy is to be restored. We owe that boost to the world as well as to ourselves.
(5) Inflation is below your target. It provides no justification for current high real rates. Nor does the rise in house prices. That may be a bubble but it does not figure in your inflation target. Moreover, it’s not your responsibility to deal with it. Galloping house price inflation is largely a question of supply and demand. If we don’t build the houses we face the consequences. In any case, it is a government responsibility to deal with it, not yours. They can do so by increased stamp duties, extension of capital gains tax, taxation of increased values, a rapid house building boost, and all the other means which lie at government’s disposal. You and we know that it won’t do any of this because it can’t take on the Great British House Buyer. We also both know that if banks and building societies lend too much, lend to bad risks and advertise to stimulate new borrowing for irrelevant purposes they have no-one to blame but themselves. Neither failure, that of the banks or the government, passes any responsibility to you unless one or other boosts the RPI inflation figure you target which neither has and neither will. In any case, you can’t deal with the bubble by higher interest rates which would only damage the rest of the economy even more in the process. Lower interest rates won’t boost the bubble much further, and in the long run only the level of earnings will determine the level of house prices. You worry about nothing if you think a percentage point or two either way makes any difference, and irrelevantly if you think the failures of others require the Bank to act.
(6) Britain’s “New Economy” is not as strong as the old because it is at bottom a low wage economy carrying record levels of debt. Raising interest rates in such a situation is far more serious and damaging than in the old industrial economy. The only way for them to go is down to keep the credit flowing and the economy going. Rates are no longer an effective regulator. With social gaps and top pay so high the high spenders don’t mind and the mass are crippled. The fact that the Bank has got away with rates higher than elsewhere and such high real rates for so long is another example of “rip off Britain”, not an effective adjustment to the new society.
Doing nothing may be a hallmark of statesmanship and we can see the temptation to earn that this month, but you do need to boost the economy and lower rates now.
Failure to do so can produce a turn around and a run down more rapid than anyone expects. The manufacturing base has been so badly undermined that slip can quickly become a rapid downhill ride.
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