But the more the market thought about that, the narrower the margin for error seemed. Indeed, if one takes the Lamont statements along with the speech of the Governor of the Bank of England yesterday evening, it is just possible to argue that Britain may not be heading back to the dreadful cycle of inflation and devaluation that has dogged it since the Second World War.
The markets, however, will require several years of deeds rather than words before they are prepared to believe it, and who can blame them?
In economic terms, Norman Lamont's speech to the conference was less important than his letter to the Treasury Select Committee. In a nutshell, the game plan seems to be that we should not re-enter the European exchange rate mechanism until we can do so with our heads held high. So the conditions are lengthy - end to foreign exchange turmoil, convergence of US and German interest rates, and so on - and explicit. The explicit conditions are perhaps less important than an implicit one: that we rejoin with a central rate that continues to bear down on inflation.
That letter should be read in conjunction with the speech of the Governor defending the DM2.95 central rate, but making the point that the sterling/dollar rate did serious damage. Taken together, it looks very much as though we will not go back into the ERM until the dollar is steady at around DM1.70, and sterling has climbed back to somewhere close to its former ERM band. The idea that we could go back in at DM2.95 is probably absurd (though it would of course be politically attractive for the Prime Minister), but the authorities very much want to squash the notion that we might go back at a central rate of, say DM2.50. We would want DM2.75 at least.
But of course we are not going back into the ERM for a year or so: it is very hard to see the conditions for entry resolved before next autumn, and the sort of 'hard' central rate noted above might not be acceptable to the other ERM members. How secure are the policy anchors in the meantime?
Not very, but they could be made better. The Chancellor has elaborated a little on his Washington statement at the International Monetary Fund meeting last month: the Treasury will look at a variety of monetary indicators but the only money measure for which there will be actual targets is narrow money (M0).
Some people would have preferred it were he also to have targeted broad money, and/or a weighted indicator of money. But he has not, the argument being that it is better to have a target for the thing you really want to influence, inflation, than to have a plethora of targets for intermediate indicators. So that argument runs that the inflation target renders these intermediate targets redundant.
That is fine, except that inflation is a lagging indicator. By the time a problem shows up in inflation it is too late. Policy has to move in advance of movements in the RPI, and what is needed are signals that will flash warnings before the damage is done. If the authorities could be trusted to read the other signals correctly then this discretionary approach might provide a strong enough anchor. Alas, they have failed so spectacularly in the past few years that no one will trust them now.
The Governor made a rather plaintive comment on this. Referring to the argument that we need the ERM anchor for stability, he said: 'It would frankly be humiliating . . . if we had to accept that we could only manage our affairs effectively and responsibly if we were subject to external constraint.' But given the record of British economic management over a long period, it is very hard not to accept that proposition: better to be humiliated than to have one's currency debauched.
How then can the one new target, that for inflation, be beefed up so that it does become a real constraint on policy? The only obvious way of doing so is through the exchange rate. Mr Lamont yesterday played down the idea that there should be a target for that, and given the grief the exchange rate has given him, you can see why. But the exchange rate is a useful lever on policy in two ways.
First, there is a direct, if lagged, impact on inflation from movements in the rate. So although the Chancellor might deny it, if we have a target for inflation there has to be an implicit target for the exchange rate.
Indeed, to meet the inflation ceiling of 4 per cent next year we probably need some strengthening of sterling from its present level. Most of the City's post- devaluation forecasts for inflation next year are running above 4 per cent.
Second, the foreign exchanges can act as an early warning indicator. They do not do this in a very ordered or rational way, but they are better than nothing. If policy seems to be going wrong, then the markets can sell the currency. So it will be up to the markets to make sure that the inflation target is taken seriously. If they feel the authorities are backsliding, they have the obvious remedy: sell.
Of course, the inflation target is only words, and words about economic policy have been seriously devalued. In publishing a target, the authorities have given a lever on policy, but nothing more. The test will come when inflation seems to be nudging up, or when a slide in sterling threatens the target and requires an unpopular rise in interest rates. All that has happened in the past 24 hours is that the authorities have made it slightly harder to refuse to increase rates when the markets feel that a threatened rise in inflation means they should do so.
This is not a lot, but it is better than nothing. Putting policy together again is going to be a long, cold haul. They have not begun that journey, but at least they are now looking down the road and realising that it will not be a lot of fun for anyone, particularly Norman Lamont. That is a sort of progress in itself.Reuse content