|
My monthly letter to the Governor of the Bank of England.
Dear Mr King
We recommend that the Bank should start the year right by reducing interest rates and indicating that its initial small reduction is the start of a sustained reduction through the year. We also urge the Monetary Policy Committee to take a New Year resolution to pay less attention to the inflation it has been preoccupied with for too long and show a greater concern for the long term health of the economy, particularly its competitiveness.
Up to this point, perhaps rightly from the point of view of an MPC anxious to establish itself and build a reputation for effectiveness at its inflation task, you have concentrated on the easy job of moving interest rates up and down by marginal shifts in response to house prices, consumer demand and credit expansion, to all of which the Bank pays far too much attention, as if they were the real determinants of inflation and subject to management by interest rates. The Bank has failed to see that house prices cannot increase exponentially unless incomes increase massively, and at their present high level there is little danger that there will not be another big surge.
So now that the Bank’s basic job has been tackled successfully, with the House Price Bubble over and the economy running well below trend, the Bank must turn its attention to the wider problems of a slow growing economy in danger of stalling by an expansion of demand which is increasingly necessary to boost the economy.
Instead of realising this the MPC, dominated by the deflationary instincts and the pawky, self-serving wisdom of bankers and ever timorous in seizing economic opportunities, has remained obsessed with a largely imaginary inflationary threat which never somehow materialises, whether interest rates go up or down. If the biggest credit expansion in British history and an oil price rise as big as that of 2005 don’t produce the galloping inflation the Bank is so obsessed with, and if inflation in Ireland fell when low 2% interest rates were imposed by the ECB then it is time to take a new look at both inflation and the interest rate shifts the Bank uses to manage it.
Today inflation is low here and all over the world. There is no real chance of the acceleration the Bank fears. Production has expanded enormously. The power of labour is broken and high immigration and globalisation compound this. Costs are being held down, as are prices because competition is so intense and monetary policy here and in Europe is keeping demand below the higher levels it could be run at. All these are the courses of low inflation. None of them are likely to be reversed. So in fact the Bank’s touches on the tiller have had little to do with managing inflation but a lot to do with articulating the Bank’s middle-class moralising and its puritanical view of how society should be run. The only real effect has been to add yet another deflationary turn of the screw on an under-run economy and to keep sterling higher than it would otherwise be. That strategy has been basic to British economic policy for too many years before and since Bank independence.
So the Bank has fulfilled the terms of its contract but failed in its wider responsibilities to the British people and the health of the economy because it has not helped to build real success, having run the economy more for the purposes of bankers and the Finance community rather than those of the producers by whom the nation lives and pays its way in the world. Responsibility for the overall economy of jobs and growth is sensibly, and rightly, written into the rubric of the Fed. Inconsiderately and wrongly it was left out of account here but the crucial fact is that those policies which have made the Bank apparently successful on inflation, have undermined the productive economy we live by.
The high pound, partly the result of interest rates higher than Europe’s and, until recently, the Fed’s, has prevented us benefiting from European markets, undermined exports and removed any possibility of the export-led growth which has been the key to economic success for all the dragon economies as well as France and Germany. It has encouraged imports and given them a high and increasing share of our domestic market leading to a gaping balance of payments deficit. This is unsustainable on any long term and will require corrective action at some stage. If this doesn’t take the form of a falling pound the Bank will have to maintain an interest rate policy of rates higher than they would otherwise be to underpin a pound which the Bank will then want to keep up through fear of inflationary consequences in any fall. This will heighten present high pound-high interest rate policies which have already kept domestic demand, the driver of the economy, lower than it would otherwise. As a result, the economy has not been powered by investment or rising productivity (which increases with production) but can’t when production is falling or stagnant. The drive has come from consumer demand largely or imports and financed by rising asset values and house prices. Both have siphoned money away from productive investment and into asset inflation. The second driver has been public spending, itself a necessary part of any good society but which is seen as competing for investment and spending. Both are weakening. Neither will rise at the same rate as 1999-2005.
So economic growth will be lower. What will now drive the economy forward? Only lower interest rates can save the situation.
Thus a period in which the British economy is widely assumed, particularly by admirers of Bank Independence, to have performed well could and should have been used to get higher growth to build up strength and made up lost ground, while the economic circumstances remained favourable. Instead we have not prepared or invested for a successful future with a competitive economy, able to pay its way in a tougher world . Thus a great historic opportunity has been wasted and there is a glaring contrast between the way Norway has used the opportunity of oil to prepare for the future and the way we have dissipated it.
Some may resist that conclusion but it can’t be gainsaid that whatever difficulties lie ahead they are better faced by an economy which has invested, rebuilt its strength and its production economy, trained its workers and modernised ready to seize every opportunity that comes. The Bank can point to none of this as the result of its short term improvisations which is why we suggest that instead of concentrating as heavily as the Bank has done on the single problem of inflation, it should focus on competitiveness too. Why shouldn’t it accompany its regular Inflation Report with a Competitiveness Report measuring just how competitive sterling, and British production, are against a range of currencies and markets and attempting to explain and keep under review the correlation between competitiveness and interest rates. The Bank must inform itself and the public on this issue because its attitudes and policies on sterling, the correlation between interest rates and competitiveness and on the importance of the exchange rate in sustaining competitiveness seem to spring from Lord Norman and Sir Otto Niemeyer rather than Keynes or even Greenspan.
Growth requires a reduction in interest rates and a sustained, cheap money policy to encourage the pound to come down from its present uncompetitive levels to stimulate exports and, therefore, compliment any expansion of domestic demand. The Bank is excessively nervous of growth. Given its propensity to believe that moderate deflation and an under-run economy constitute benign economic management the Bank will fear that inflation, growth and a lower exchange rate must inevitably result in inflation. In fact, though, growth at a much higher level than the lame levels of the last few years is the only way of defeating inflation in the long term because it increases productivity, brings down unit costs and brings a bigger and growth economy and present inflated asset prices into a closer, more acceptable, correlation.
The economy needs lower interest rates. We propose a half point reduction now, two percent more over the year to take us from the highest to the lowest. This will produce the following effects:
- It will boost the economy. A growth rate below trend is economic failure which will require more taxes and more borrowing to provide the level of public service the public want. Only cheap money can re-boost the economy out of present doldrums.
- It will encourage the investment Britain needs in the productive sector. Note the contrast between Germany, which has invested in its productive economy, slimmed down and cut costs, often by moving production east and is now far better placed to benefit from any European upturn than we are after our own pursuit of bubbles. They stand ready to move forward powerfully if demand in Europe expands. We have wasted time.
- An economy crippled with debt needs substantially lower interest rates, long maintained, if it is not to stall into a wind-down difficult to reverse. No use being moralistic about it and preaching saving and virtue too late in the day. There has been a conspiracy between banks and government to facilitate credit expansion, sustain consumer demand, and keep the economy growing by what amounts to privatised Keynesianism. Having chosen to go down that route it would be ruinous to attempt now to reverse out or stop progress. Having chosen the path of growth the Bank has a responsibility to sustain it and not punish those who did as Government and the Banks wanted them to by guzzling. If the policy runs into trouble or slows we need to boost the growth by lower interest rates. Without them the economy stalls and with household debt levels so high that will be very painful. Which gives the Bank the responsibility to keep consumer demand high until new motors of growth, such as a house-building programme and export led growth, can kick in. These too require lower interest rates.
- The Bank’s fears of further house price rises and more inflation if interest rates or the pound fall are both unrealistic. The inflation bogy is dead. Note that it hasn’t returned even with high oil prices. As for house prices they have peaked. This year’s rise will be small. They won’t rise again in any substantial way until a big rise in earnings takes us towards a new house price multiple. Which it won’t for some time. So unless incomes increase massively there need be no fear of another house price bubble. Similarly, and for the same reasons, lower rates won’t lead to another huge credit boom, though they will help people to carry the burden they have already taken on.
- There is no prospect of tackling the gaping balance payments or of enjoying export led growth without a substantially lower exchange rate. Domestic expansion without that will flicker out and its benefits will wash overseas to imports, making the import export balance far worse. As in the USA, living by importing is a finite process, though America can sustain a gaping deficit and the resulting accumulation of debt far longer than anyone else because of the power of its economy, the prestige of the dollar which allows the US to borrow in its own currency and the willingness of the Chinese to buy American debt. We have none of these advantages. Just a consumer bubble getting weaker.
Perhaps the Bank should consider whether or not we are at the end of the golden weather. Low growth and a propensity to lag behind the world lie ahead unless the Bank embarks on a process of interest rate reduction, for not only are current prospects poor, but the long term problems of an unproductive, uncompetitive economy which cannot pay its way in the world and survive post-oil, all of which we have been able to ignore for so long, must eventually be faced. If we can’t pay our way when we have the big benefit of oil, the prospects for maintaining living standards while going cold turkey on an extreme dose of import addiction will be dire indeed. Living in a fool’s paradise by increasing consumption while restricting production is not a long-term strategy. We hope the Monetary Policy Committee will consider these concerns seriously and recognise that an inverse Micawber strategy of waiting for something to turn down before reducing interest rates will delay the necessary outcome for far too long. Which doesn’t stop us wishing yourself as Governor, and the MPC, as happy a new year as we can have with interest rates at this level. |
