Time to still siren song on sterling

If only the Bank of England would stop raising interest rates the pound would drop ... all kinds of apparently sensible people have accepted this nonsensical reasoning

The manufacturing lobby is in full voice. The theme of its siren song is that if only the Bank of England would stop raising interest rates the pound would drop, exports and investment would pick up, and balance and harmony would be restored to the economy. The descant to this chorus is the line that the Chancellor of the Exchequer would have made it a lot easier if he had raised consumer taxes in the Budget, with yesterday's retail sales figures confirming the scale of the windfall-fuelled spending spree.

All kinds of apparently sensible people have accepted this nonsensical reasoning. It has three main flaws. The first is to conclude that because manufacturing is flat and industry's export orders starting to decline, the economy cannot be overheating. The second mistake is to argue that it is better to use taxes than interest rates to manage the economy in the short term. The third is the belief the Bank of England can easily manipulate the level of the pound by adjusting interest rates.

Take the first point. It is perfectly possible for manufacturing to be depressed while the rest of the economy remains buoyant. Manufacturing makes up only 23 per cent of national output, little more than finance and business services at 19 per cent. As a recent circular by Peter Warbuton at investment bank Flemings points out, there could scarcely have been a greater contrast between the performance of these two sectors during the 1990s.

Although growth in manufacturing started picking up in late 1991 (the trough of the recession preceded Black Wednesday in September 1992, contrary to popular myth), the recovery in business and financial services and telecommunications has been much sharper. They are currently expanding at an annual rate of nearly 10 per cent in real terms, compared to flat manufacturing output.

Mr Warbuton argues that this divergence between sectors reveals the "madness" of setting policy according to aggregate figures on the economy. He writes: "Hi-tech business services, financial and telecommunications services are not subject to the same output constraints as blast furnaces and assembly lines."

This is highly debatable - that bottlenecks are less tangible in services does not mean they do not exist. They instead take the form of labour shortages or congestion. But skip over this. He could also make a similar argument about the divergence between regions, with the fortunes of London in sharp contrast to Crewe, say. The London and south-eastern labour market will hit skills shortages well before the rest of the country.

The trouble is economic policy has to be set according to some kind of aggregate measure rather than one sector of the economy. Whether it should be industry or financial services depends on your assessment of the balance of risks.

This is something about which there is obviously profound disagreement at present. Some economists reckon there is a strong parallel between the late 1990s and the late 1980s. Many of the same indicators are flashing red or amber, but now as then the delays in the inflation process mislead many commentators into thinking there is no danger in this. Suggestions that the economy's trend growth rate had increased permanently or that flexibility in the jobs market meant unemployment could fall further without triggering wage inflation were two-a-penny a decade ago. They have resurfaced with a vengeance recently.

Other experts say there might be a closer parallel with the early 1980s, when a tough Budget, high interest rates and strong pound plunged Britain into a scarring recession. Growth had been picking up through 1979, and rising oil prices made the inflation penalty pretty immediate.

Perhaps I am inclined to put more weight on the boom theory simply because I live in London, just as industrialists put more weight on the gloom theory because they don't. But it is worth pointing out that policy in this country has hardly ever erred on the side of being too cautious. Typical British mistakes have been giving in to the complaints from industry that the cost of borrowing is too high, the pound too strong or the tax breaks too miserly.

The good thing about relying on small changes in interest rates to adjust policy over the cycle, however, is that if this view turns out to be too tough, the Bank of England can easily reverse it. Suppose the members of the Monetary Policy Committee decide to raise rates by another quarter point next month, as they should if tomorrow's figure for second-quarter GDP is as robust as yesterday's retail sales figures. Suppose August and September then bring news of a drop in export volumes and a slowdown in the spending of the consumer windfalls, and the flash estimate of third- quarter GDP the following month is weak. The Bank could then revise its inflation forecast and cut interest rates. Three months with rates at 7 per cent rather than 6.75 per cent would not be catastrophic.

This is why the Chancellor is right to argue that Budgets should set taxes for the medium term, not for fine-tuning over the economic cycle. Although he actually raised taxes on companies rather than consumers, despite his claims to the contrary, this is an unhelpful mix rather than a terrible error of judgement. After all, he could hardly have come back with another Budget in November to cut taxes again if the economy does turn out to be weakening.

And, as Gavyn Davies has pointed out in his column in The Independent, fiscal policy is very tough indeed. Mr Brown is planning no real-terms increase in the public spending total. If any single part of the economy is bearing the burden of austere policies, it is public services rather than manufacturing.

The final point to make about industry's special pleading is that the Bank of England cannot necessarily make the pound fall by cutting interest rates. If it did so at a time when the economic indicators were still warning of inflationary risks - as they are - the foreign exchange markets would simply look forward to an even bigger rise in interest rates later. It would be a postponement of the inevitable. The last government unleashed faster growth than the economy can sustain and it will sooner or later have to be brought back under control. What's more, the bigger the boom, the bigger the bust.

There is nothing to be done about the fact the British economy is further advanced in its cycle than the rest of Europe, or about the uncertainties over EMU that are depressing the continental currencies. All the special pleading in the world cannot bring the pound down. This is something that time, rather than the Bank of England, will have to set to rights.

Arts and Entertainment
Arts and Entertainment
Judi Dench appeared at the Hay Festival to perform excerpts from Shakespearean plays
tvJudi Dench and Hugh Bonneville join Benedict Cumberbatch in BBC Shakespeare adaptations
Arts and Entertainment
Exhibition at the Centre Pompidou in Metz - 23 May 2012
Is this how Mario Balotelli will cruise into Liverpool?
Ronahi Serhat, a PKK fighter, in the Qandil Mountains in Iraqi Kurdistan
ebooksAn evocation of the conflict through the eyes of those who lived through it
Arts and Entertainment
Poet’s corner: Philip Larkin at the venetian window of his home in 1958
booksOr caring, playful man who lived for others? A new book has the answer
Matthew McConaughey and his son Levi at the game between the Boston Red Sox and the Houston Astros at Fenway Park on August 17, 2014 in Boston, Massachusetts.
advertisingOscar-winner’s Lincoln deal is latest in a lucrative ad production line
Arts and Entertainment
Alfred Molina, left, and John Lithgow in a scene from 'Love Is Strange'
A model of a Neanderthal man on display at the National Museum of Prehistory in Dordogne, France
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Junior Quant Analyst - C++, Boost, Data Mining

£25000 - £35000 per annum: Harrington Starr: Junior Quant Analyst - C++, Boost...

Service Desk Analyst- (Desktop Support, Help desk)

£25000 - £35000 per annum: Harrington Starr: Service Desk Analyst- (Desktop Su...

Junior Quant Analyst (Machine Learning, SQL, Brokerage)

£30000 - £50000 per annum: Harrington Starr: Junior Quant Analyst (Machine Lea...

UNIX Application Support Analyst- Support, UNIX, London

£45000 - £55000 per annum: Harrington Starr: UNIX Application Support Analyst-...

Day In a Page

Air strikes? Talk of God? Obama is following the jihadists’ script

Air strikes? Talk of God? Obama is following the jihadists’ script

The President came the nearest he has come yet to rivalling George W Bush’s gormless reaction to 9/11 , says Robert Fisk
Ebola outbreak: Billy Graham’s son declares righteous war on the virus

Billy Graham’s son declares righteous war on Ebola

A Christian charity’s efforts to save missionaries trapped in Africa by the crisis have been justifiably praised. But doubts remain about its evangelical motives
Jeremy Clarkson 'does not see a problem' with his racist language on Top Gear, says BBC

Not even Jeremy Clarkson is bigger than the BBC, says TV boss

Corporation’s head of television confirms ‘Top Gear’ host was warned about racist language
Nick Clegg the movie: Channel 4 to air Coalition drama showing Lib Dem leader's rise

Nick Clegg the movie

Channel 4 to air Coalition drama showing Lib Dem leader's rise
Philip Larkin: Misogynist, racist, miserable? Or caring, playful man who lived for others?

Philip Larkin: What will survive of him?

Larkin's reputation has taken a knocking. But a new book by James Booth argues that the poet was affectionate, witty, entertaining and kind, as hitherto unseen letters, sketches and 'selfies' reveal
Texas forensic astronomer finally pinpoints the exact birth of impressionism

Revealed (to the minute)

The precise time when impressionism was born
10 best men's skincare products

Face it: 10 best men's skincare products

Oscar Quine cleanses, tones and moisturises to find skin-savers blokes will be proud to display on the bathroom shelf
Middle East crisis: We know all too much about the cruelty of Isis – but all too little about who they are

We know all too much about the cruelty of Isis – but all too little about who they are

Now Obama has seen the next US reporter to be threatened with beheading, will he blink, asks Robert Fisk
Neanderthals lived alongside humans for centuries, latest study shows

Final resting place of our Neanderthal neighbours revealed

Bones dated to 40,000 years ago show species may have died out in Belgium species co-existed
Scottish independence: The new Scots who hold fate of the UK in their hands

The new Scots who hold fate of the UK in their hands

Scotland’s immigrants are as passionate about the future of their adopted nation as anyone else
Britain's ugliest buildings: Which monstrosities should be nominated for the Dead Prize?

Blight club: Britain's ugliest buildings

Following the architect Cameron Sinclair's introduction of the Dead Prize, an award for ugly buildings, John Rentoul reflects on some of the biggest blots on the UK landscape
eBay's enduring appeal: Online auction site is still the UK's most popular e-commerce retailer

eBay's enduring appeal

The online auction site is still the UK's most popular e-commerce site
Culture Minister Ed Vaizey: ‘lack of ethnic minority and black faces on TV is weird’

'Lack of ethnic minority and black faces on TV is weird'

Culture Minister Ed Vaizey calls for immediate action to address the problem
Artist Olafur Eliasson's latest large-scale works are inspired by the paintings of JMW Turner

Magic circles: Artist Olafur Eliasson

Eliasson's works will go alongside a new exhibition of JMW Turner at Tate Britain. He tells Jay Merrick why the paintings of his hero are ripe for reinvention
Josephine Dickinson: 'A cochlear implant helped me to discover a new world of sound'

Josephine Dickinson: 'How I discovered a new world of sound'

After going deaf as a child, musician and poet Josephine Dickinson made do with a hearing aid for five decades. Then she had a cochlear implant - and everything changed