Economic Commentary: First results for Treasury glasnost

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The Independent Online
The full flowering of the Treasury's recent glasnost occurred last week, with the publication of the first of the Bank of England's inflation reports, along with the initial offering from the panel of independent forecasters (or 'seven wise men', one of whom I have the honour to be).

The Chancellor's intentions when he launched these parallel initiatives in his Mansion House speech last October have been widely impugned, but I can think of no reason why he should have saddled himself with these mechanisms unless his intentions were honourable. In the wake of sterling's departure from the exchange rate mechanism, there was clearly a strong feeling that the Treasury needed to provide itself with a more formal system for garnering outside opinion (although it had never been as isolated as is widely supposed, thanks largely to the hospitality of the Reform Club).

More important in the long run, the new mechanisms were presumably intended to provide a modest check on the Government's ability to pursue the 'wrong' economic policy for political ends - by focusing public attention on this possibility, should it occur.

The British way of government has never been very good at checks and balances. This stems in part from the fact that we are a unitary state, with an ever- decreasing role for local government. But even Parliament itself exerts only sporadic checks on the power of the executive. That, some would argue, is one of the enduring strengths of our system. It is possible to act when action is needed - and that action can be informed by the cold rationality of the civil service.

The continuing failure of the economy is, however, resulting in ever more strident calls for political reforms. Fortunately, the absurd notion that proportional representation would improve economic performance has shown some sign of fading away (and should do so further when people realise that Italy is moving to our electoral system precisely because proportional representation has damaged its economy so profoundly).

Formidable barriers

But Whitehall's predilection for official secrets is another matter. It is hard for any democrat to argue that decisions that are made behind closed doors and then unveiled without proper debate to a rather befuddled public can be the best way of proceeding. If the Chancellor's new mechanisms can open up public discussion of economic policy even a fraction, then they will play a useful, if rather modest, role.

Unfortunately, as we have already seen with the media's tendency to trivialise the 'wise men', these initiatives are up against formidable barriers. Not only does news reporting in both press and television usually wish to reduce economic discussion to a mundane level, it does this because it is reflecting, just as much as shaping, the interests of its consumers. Most ordinary citizens would no more read this column than I would read an equivalent piece on Ruritanian folk dancing (and shame on me, no doubt, for that). Neither the Bank nor any number of wise men will make one jot of difference to that basic truth.

What they can do, however, is occasionally give the electorate the vague impression that something is amiss. That vague impression can be fostered by politicians outside the Government, picking up ammunition from the Bank and the panel. Economists have of course been used and abused in this way since time immemorial, but the Chancellor has voluntarily chosen to institutionalise this process to a greater extent than ever before. If the new mechanisms are working, he can expect to have reason to curse them from time to time.

This could frequently put the Bank and the panel - but especially the former - in awkward positions. The Chancellor has established an arrangement that will interest the public only when it is critical of him - a kind of neon-lit raising of the Governor's eyebrows.

I am far from convinced that it will be easy for the Old Lady to adapt successfully to her new, quasi-independent role in life. At the end of the day, ministers will continue to set interest rates, and at the end of the day the Bank cannot be seen to oppose these decisions in public. Not only would this expose the impotence of the Bank in setting monetary policy, but it would also carry great dangers in the financial markets. Even in extreme cases like 1976, when Governor Richardson quite clearly thought the Labour government was driving the British economy to the knacker's yard, the Bank generally kept a discreet silence about the direction of policy.

The new governor-designate, Eddie George, is far too wily a campaigner to believe that he can run the Bank as a glorified think-tank in permanent opposition to the Treasury. At times of economic stress, this is bound to limit both the independence and the efficacy of the inflation report since, if the Bank cannot openly oppose interest rate policy, it follows that the report cannot openly argue that policy is inflationary.

None of these strains was visible in the first inflation report, published last week. The bulk of this report consisted of a detailed analysis of past inflation data, from which I received the overwhelming impression that the disinflationary forces in the domestic economy remain very strong.

Labour costs

As the Bank argues, it is perfectly normal for labour costs in the economy, and especially in the service sector, to adjust with a considerable lag to the effects of recession. This is now happening, so service price inflation can be expected to fall considerably further over the next two years. Furthermore, although import prices have risen sharply in the wake of devaluation, these increases are so far being absorbed in the profit margins of producers and distributors, which (as the Bank again points out) have remained wide enough in the recession to be able to perform this role now.

Despite all this, the crucial pages on inflation prospects in the Bank's report conclude that underlying inflation will remain close to the top of the Government's 1-4 per cent target range, and - much more controversially - suggest for no very apparent reason that the risks relative to this forecast are 'on the high side'. This then underpins the Bank's judgement that base rates should not fall any further, and may have to be raised if sterling continues to depreciate.

I am pretty convinced that the Bank is too pessimistic about inflation prospects in the next couple of years, but I cannot prove it. I would be very concerned if the Government were tempted to listen to the Bank's advice and raise base rates in the event of a further decline in sterling. This would not only be unnecessary, but positively counter-productive.

On this, I am pleased to say, the panel has made a valuable contribution. There is now a strong consensus on the panel that the main risk facing the economy is a prolongation of recession, not a take-off in inflation, and the panel specifically says that interest rates should not be raised to combat a temporary rise in inflation stemming from devaluation. I hope the Chancellor listens.