Back door strategy to lower rates
Sunday 11 June 1995
And, of course, they are not much about economics, despite the title. Bosnia, hardly an economic issue, will loom large in the debate.
It may be fashionable to be snooty, but wrong. These meetings are useful, none the less, and not just to the politicians who go to them. They are useful to the rest of us, because they can help us crystallise in our minds the key issues in the world economy: what really matters at this stage of the economic cycle, and what actions might be taken by the policy makers in the coming months.
And so it is with Halifax. There are a number of things which the heads of state can talk about which do have a genuine economic element to them. These include detail matters such as the future of the International Monetary Fund and the World Bank, both of which will need to be reformed during the next few years and whose future can really only be decided by the main developed countries, who, after all, pay for them.
There is a more immediate issue in the US/Japan trade war, which will continue at a fair level of ill-temper through the summer, and which in a way needs to continue because the scale of the Japan/US trade imbalance is fundamentally unhealthy for both sides. But there is - as in all trade disputes - a danger of ill-temper transforming into something worse, and the summit is useful in checking that tendency.
Both are worth looking at. What appetite is there for reform of our international organisations? Are the financial markets right in taking a relatively benign view of the threat to international trade.
But beyond these, and of course, noble sentiments about Bosnia, what? There is one important issue which ought to be discussed at the summit, for it may require international financial diplomacy at a high level. The question can be put in general terms: what should be done, if anything, if economic growth falters later this year? Or it can be put in specific ones: do we need a co-ordinated world cut in interest rates very soon?
To explain. Have a look at the chart. This is constructed by BZW, the stockbrokers, from various national confidence indicators and shows the proportion of companies which expect conditions to improve or deteriorate in the coming months. Business confidence within the Group of Five (the summit nations minus Canada and Italy) has self-evidently slumped in the last few months. True, the business community may be no better at forecasting the world economy than the finance ministries or City economic pundits, but it deserves attention because real business people are reacting to real demand for their products. This is not a political response by voters in one country moaning about the lack of a "feelgood factor"; it is the real thing.
You can see what has happened. The mood of world business is not only more sombre now than at any period since the long recession of the early 1990s; optimism has also evaporated more rapidly than it did during the pause in growth in the middle 1980s. This is important, because the big issue facing the world economy at the moment is whether we are seeing simply a pause in the recovery or whether it is in trouble.
We see some signs of trouble here in Britain in the tailing-off of growth in industrial production and the plateau in retail sales. But from a world point of view, we are not very important. Seen globally, the problem is that the largest economy, that of the US, is clearly slowing, while the second largest, Japan's, has hardly begun to grow again.
Germany and France are moving forward, but are still quite fragile - France in particular, with its unemployment of more than 12 per cent.
Even those of us who believe, as I do, that we are merely seeing a pause in growth and that this is perfectly normal at this stage of the cycle, must of course admit that there is a possibility we may be wrong. If we are, then something will be needed to push the expansion back on track.
The most obvious something would be a co-ordinated cut in world interest rates.
That is not going to happen this week, for two reasons. First, it is not yet clear that one is needed. Second, monetary policy is run to a greater or lesser extent by central banks, rather than finance ministries. Central bankers do not go to economic summits and jealously guard whatever independence they have in setting rates.
It is a good thing they do, because it may be that the best way to get world interest rates down is not to have such a co-ordinated cut.
Setting world economic policy is a complex interaction between government spending and taxing plans, monetary management and market expectations. It always has been, but the last couple of years have shown how the role of market expectations has become relatively more important. Most people have long realised that governments have to run reasonably sound fiscal policies, because if they do not do so, change will be forced on them by the markets. More recently it has become clear that governments (and/or central banks) also have to run appropriate monetary policies or those too will be changed by markets.
Of course, sometimes, finance ministers do defy the markets - and are proved to be right. Our Chancellor got away with not increasing British interest rates last month because, initially, the markets reckoned that the rise was merely being delayed, and then realised that the decision was validated by economic data. But this does not happen often.
Monetary policy works best through influencing expectations. We are going to have a test case in Britain of this on Wednesday, the night of the Mansion House speech. The Chancellor has traditionally used this speech as a statement of the Government's economic policy and this year is expected to announce new inflation targets. He could simply roll over the present target of 1 to 4 per cent, but with the aim of being below 2.5 per cent. Or he could reduce it. Or he could increase it.
Were he to tighten the target, you might imagine this would lead to higher interest rates: the Bank would suck its teeth and warn that policy would have to be tightened to make the targets credible. But if he were to loosen it, the markets would feel he had gone soft on inflation, there would be a run on the pound and eventually that would have to be stopped by, yes, higher interest rates. It would not, therefore, be wise to raise the inflation target.
So if it does become clear in the autumn that the slowdown is serious - that the gloom of the business community is justified - then somehow the world has to engineer a fall in rates without this being seen to be politically motivated.
I think there is a way of doing this. It is important that the fall is not co-ordinated. Instead the central bank with the most credibility, the Bundesbank, has to make a cut. That would allow the French to come down. After a decent interval, the Japanese could get rates down, too. Then the US could do so, and maybe, maybe, Mr Clarke might find that the next move in Britain was down, not up.
Economic summits are interesting as a guide to political intent. This one deserves notice for that. But they cannot do much to help the recovery; its future will be determined on that frontier between the monetary authorities and the financial markets.
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