|
Dear Mr King
This month`s advice of the Labour Economic Policy Group to the Monetary Policy Committee is to reduce interest rates, preferably by as much as two percent to bring them down to the level of other advanced countries, but certainly by a more substantial amount the usual cautious, little by little approach would allow. The reduction, necessary last month, and which would have occurred then had it not been for the London bombings, now needs to be at least doubled to one half of one percent, preferably more. That is less than we think necessary but it would be more acceptable to you and would indicate to the world how serious the softening of the economy is becoming and how great the need for action to boost it. It would also give the necessary signal to markets that rates are on the way down, the pound with them.
The economy now needs a substantial boost to demand. Hitherto it has been driven by consumer demand, boosted by the credit bubble and by rising house prices. The other booster is increased government spending and the expansion of employment in the public sector. Both have boosted growth and employment, though at the expense of a steadily widening trade deficit, because the real production economy in Britain for export and productivity has been declining because of high interest rates penalising investment, and an overvalued pound penalising exports. Both have ensured that our position in European markets has declined and that we have not been able to take advantage of the continued growth in the American and other dollar markets.
Now these drive motors are both running down as consumer spending fails, house prices are continuing to slide and public spending has plateaued. They leave the nation crippled with higher levels of debt, just as the continued wind-down of manufacturing accelerates with closures such as Bird’s Eye and Acordis in Grimsby, Rover, Granville Technology and others nationally, and thousands of smaller firms which have kept going hoping for an improvement which hasn`t materialised go under. Gloom and despair are everywhere in retailing, even in clothes and textiles where the product is largely imported and profit levels high. It must therefore be assumed that many of the new jobs created in consumer businesses, from restaurants and entertainment, to supermarkets are now at risk.
In addition house prices are slipping, reducing the potential for liberating money for consumption and consumers, heavy with debt, seem to be pulling in their horns and reconciling themselves to grappling with their debt problems rather than consuming more. Government spending has plateaued. The expansion of employment in the public sector stands to be reversed as Gershon economies take effect.
With the economy in this precarious situation we must emphasise how quickly it can go into reverse. Unemployment now rising means that government deficits increase creating a need for more taxes or borrowing and ending the benign cycle of more employment meaning more taxes. At the same time falling house prices can quickly create negative equity problems and depress activity even more. Look at how quickly the Lawson boom was followed by nemesis. A substantial reduction of interest rates and a boost to demand are the only ways to top this and protect the economy from such a steep slide. The reduction needs to be rapid given the fast pace of deterioration. High tides turn and run out quickly on shallow beaches. Since the growth of the last few years has no substantial underpinning in production productivity or competitive advantage, the spending tide will do the same.
The Bank’s control of interest rates is a management regime looking for a role and an ideology. Your rubric puts inflation at the centre in an age when it is only a minor problem. That lack of a central core role causes the Bank to cast around for new roles as house price regulator or sterling defender. Scientific management based on detailed knowledge of the economy is replaced by banker instincts of a very traditional and outdated kind. Instincts take over from statistics and even sense.
The Bank is navigating by the seat of its pants, then justifying its actions by pure mythology, such as the usual argument that though inflation is low, measures taken will ensure it comes into line in two years` time. This is mysticism not management. It is surely time that the Bank and the MPC made the basic principles by which they manage explicit. Then the nation can judge what they are about and why. Analysts praise its skill at minor touches of the tiller but we see little evidence of this being effective beyond bobbing about on a tide of economic trends which have ensured low inflation and easy, even inevitable, growth. Thus all that the Bank`s ministrations have really secured is growth lower than it could or should be, interest rates higher than they needed to be, damage to production deeper than any sane country should accept and a pound higher than is safe for a competitive economy struggling to pay its way in the world. Stability may have been the result in a situation of low, but steady, growth, but the Bank`s real role has been as a damper, a role which imposes high costs in terms of growth forgone, opportunities missed, unbalanced development, and continuing underlying damage to the productive side of the economy on which our future and employment ultimately depend. That is why it is now important for the Bank to make explicit the ideology and attitudes on which it works, assess the consequences of its policies on the real economy, and analyse the role of the exchange rate in management as well as its effects on the economy.
All this is important because a modern economy based on lower levels of taxes, wages and social support than the European model must be run at full tilt to sustain high and improving levels of employment which alone can support the expansion of credit necessary. Now that Keynesian demand management has essentially been privatised it is liable to sudden and substantial contractions when and if difficulties appear. If the state is disinclined to play its full role in demand management, as New Labour is, then a greater weight of responsibility falls on the private regulator. In the United States the logic of this has been accepted by the Fed over the last few years and every lever has been set to “go”. In Britain it hasn’t because too much of the old banker mentality and a monetarist thinking lingers on in a regulator and a financial community whose range of responsibility is too narrowly focussed on the dead enemy of inflation. This produces a stodgy conservatism which precludes the skills at high wire balancing now necessary and well demonstrated by the Fed.
The Bank may find this criticism too harsh after the adulation it has received for its management skills from more orthodox commentators. It must, however, face up to the responsibility of making its reasoning and instincts transparent and justifying its actions in terms of its thinking so that the wider public can judge its performance in the light of what needs to be done.
The present juncture provides an interesting test. If the Bank reduces interest rates by one quarter of one percent, or even half of one percent, then it is accepting that it has no other answer to the problem of a slowing economy than to restoke house price inflation and the credit expansion which have kept us going so far. If it reduces rates by more, as we urge, then it is moving towards the long term answer we consider necessary of expanding demand and bringing the pound down substantially to restore competitiveness, and allow the necessary rebuilding of the productive economy to begin. This alone can produce the dynamism, innovation and expansion in the productive economy as distinct from the consumer economy. In this a thousand plants can blossom and a million new jobs be created. That contrast may be crude. Yet the productive economy offers far better prospects than burdening people with ever more debt at a time when the economy isn’t generating the well paid production jobs to bear it. Our advice to the Bank is implicit in all this. Think of a rate reduction then treble it. Facilis descensis Avernis. But now it`s time to retrace steps. That is more difficult and painful but increasingly necessary. |
