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Dear Eddie
Your Monetary Policy Committee is divided. With no consensus on the future course of inflation it isn’t sure what to do next. In that situation it will play safe and opt for no change. This won’t please the pundits and institutions who represent Britain’s excessively powerful financial interest.
They are clamoring for an interest rate increase because house prices are increasing where they live, raw materials (aka oil prices) have risen, and there is slight wage pressure in the service sector. You, however, should discount both this and the vested interest of Finance which always likes higher interest rates.
Yet maintaining the status quo instead of continuing to fidget rates down in the way committee decisions inevitably move will waste a great opportunity. We need to go for growth and expand through whatever strains appear, to the higher levels of growth, investment and employment which will build a healthy economy. So our advice remains the same. Reduce interest rates to European levels: there is no reason why ours should be double theirs. Get the Pound down by words and deeds. Announce that you are setting the economy on the growth path because with production increasing, productivity will rise, costs per unit of production will fall and economies of scale will all hold inflation.
Being a body of academic tinkerers living from month to fretful month without any collective or far-sighted vision for the nation you will want technical reasons for embarking on this growth strategy. They are already clear.
- Inflation is low and will remain so. It would have undershot your target by enough to require you to report failure to the Chancellor had oil prices not risen. Other prices haven’t. Oil is more like to come down than increase further. There is no risk of igniting it by higher growth.
- Current fears of inflation are largely based on asset, particularly house price, inflation. Yet that pressure is mainly in the South East and minimal elsewhere. There is dispute between building societies about the scale of the increase and no indication that this is a bubble of the Seventies and Eighties type. Indeed, house prices and earnings seem to be in closer alignment than for some time.
- Consumer demand is higher than predicted and higher than is sustainable but the reasons for this are asset inflation making people more likely to spend, low inflation, doing the same, and easy credit produced by over-capacity in a financial service industry which is "thrusting money" at people. Being more optimistic they are spending it.
- You are dealing with two economies, the South East where whatever inflationary pressures now exist are concentrated because of its higher costs and the inefficiencies of its excessive concentration of people; and the rest of the country, particularly the North and Midlands, where manufacturing has its home. There house prices are lower and rising more slowly while unemployment is still high. There, too, the overvaluation of the Pound has had its full effect. With an even wider stretch between its component economies the European Central Bank has given priority to the needs of the industrial economy as the power house, at the expense of compounding the froth and bubble of, say, Ireland. British priorities should be the same and give priority to the production economy as they have.
- British producers have kept going despite the overvalued Sterling in the hope of better times. They have been exporting without profit, cutting investment, research, design and development, and all the other basics of future strength to improve competitiveness and hanging on to Labour – all finite processes - in the hope that things would get better. That can't happen until there is a genuine increase in demand at home and overseas for British production. It won't come until the Pound falls substantially.
It is time your committee looked at the fundamentals of the British economy. They are far from healthy :-
- The pound remains substantially overvalued. We put the overvaluation at over 20%. Others put it lower but there is no way production in this country can do anything but shrink, shed Labour, and batten down hatches if it is sustained. Your committee is effectively still pursuing the policy described by Keynes in The Economic Consequences of Mr. Churchill, fighting inflation by making imports cheap and forcing British firms to cut wages and reduce employment. This undermines Britain's strength and our long term ability to fight inflation.
- Imports are rising at double the rate of exports so the balance of payments has got substantially worse because of overvaluation, and will get worse again.
Eventually this will undermine confidence in the Pound because we do not have the power of the American economy to run huge deficit and keep the exchange rate higher. When the Pound falls there will be an immediate clamor for you to increase interest rates to resist the necessary fall in the exchange rate. Far more sensible to manage it down now while you have freedom to maneuver.
- In the long term how does an economy with a shrunken and inadequate production sector and an inflated but dominant financial sector survive as the oil contribution to the economy and the balance of payments reduces? In that situation it is not responsible to damage manufacturing further or to lock it in to this shrunken state. It still pays our way in the world. It has to expand as oil's contribution falters. What else can sustain our standard of living, pay for the imports and generate jobs in that situation? You are focused on the narrow objective of inflation at 2.5% but attitudes are conditioned by perceptions about the appropriate scale of manufacturing as against services in the economy. So it is necessary to have answers, or at least attitudes, on this basic issue. What are they?
We have been persistent in putting these questions to the MPC and are disappointed in that we have received no answers. There has been no attempt to discuss or face up to such basic concerns, and little action except a fidgety tinkering with interest rates which remain high historically in real terms, very high in European terms.
So we urge you to reduce interest rates to the European level and signal to markets that you intend to boost the economy to real growth. With surplus capacity and people to fill all the jobs created, growth does not mean inflation. An increase in production and boosting productivity will reduce it. So why does your committee consider that Britain is uniquely incapable of growing on the sustained basis of, say, the US?? Are our workers more slothful and greedier, our unions more powerful, our capitalists more incompetent and timid? Why can't we do what everyone else has done, particularly now that the opportunity is better than it has ever been and only high real interest rates and our overvalued exchange rate stand in the way?
Government has began to tell Japan how well Euroland is doing because of the Euro. Surely you and your committee should explain to Britain and Japan why we are deprived of the benefits Europe is getting. This can only be because we are not allowed the low interest rates and the competitive exchange rate they enjoy. Why? Growth is central for the Labour Economic Policy Group as it should be for British economic management. In the light of the constraints and the rubric under which you live "give growth a chance" is your best slogan. Provided your committee understands that what is now described as "growth" verges on the pathetic. Long term growth at 2% or less and industrial production up only 2.5% above 1995 are inadequate.
Unemployment at 1.7 million on the ILO measure is still high. What we are seeing now isn't a soft landing, still less the discovery of a new economic paradigm of growth without inflation but a credit fuelled boost to consumer demand which will spill out not into investment in the productive economy but into consumer demand and imports making us Europe’s consumer of last resort and boosting their recovery at our expense. Real growth is stalling. So is the productive economy which cannot live with this exchange rate. You now have a substantial degree of freedom to reduce interest rates to boost the economy. Inflation is very low and shows no sign of rising, apart from house prices. So our advice must be GO FOR IT. |
