Leading Article: Not before time

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The Independent Online
YESTERDAY'S one-point cut in interest rates may have been unexpected, but it was far from being ahead of time. The Government was stung into action by last week's atrocious unemployment figures. But the arguments for a further cut had been apparent to most observers, including the Treasury's own 'wise men', for several weeks. Among the factors cited by Norman Lamont yesterday in justifying the move were the good prospects for low inflation, the continuing fall in house prices and the low level of pay settlements. To those may be added the expectation that manufacturers will continue for the most part to absorb the increased cost of imports resulting from the devaluation of sterling.

The cut was naturally welcomed by businessmen and mortgage-holders alike. Yet its immediate effect will only be marginal. As experience in the United States and previous reductions in this country have shown, time is required for such reductions to have any significant impact on economic recovery. Just as high interest rates took about two years to restrain the spending boom of the Eighties, so the lower rates produced by cuts totalling 4 per cent since sterling left the European exchange rate mechanism last September will only gradually be translated into greater consumer confidence. Their main impact at this stage of the cycle is to enable both businesses and individuals to reduce their debts, and so bring forward the date by which a proper recovery can begin.

An even longer lag may be expected between the start of any such recovery and a drop in this country's rapidly rising unemployment figures. Last week's were genuinely shocking, showing as they did a quarterly fall in employment twice as high as in any other quarter during this recession. The cost to the Treasury in lost revenue and increased benefits is bad enough. Even worse is the psychological effect of such figures on those afraid of losing their jobs, and so of entering into any new financial commitments. Only when the economy is growing at around 2 per cent are we likely to see any turnround in the unemployment statistics.

The political priority is to promote a proper recovery without aggravating the twin deficits of the budget and the balance of payments. First, a further interest rate cut of 1 per cent should be made at the time of the March Budget. Second, the Chancellor should, in the Budget itself, announce medium-term fiscal plans showing that the deficit is going to be dealt with. The steep rise in the public sector borrowing requirement has prompted widespread speculation that the spring or autumn Budget will include increases in taxation and/or a widening of the VAT base.

Fear of unspecified tax increases can have a no less damaging effect than an actual rise. To increase the tax burden - and so reduce spending power - this year, before a proper recovery is under way, would be madness. So it would be sensible for the Chancellor to clarify the situation by announcing in March how taxes will change in 1994, even if the effect is to advance some forms of spending. Failure to remove uncertainty about both taxes and the surge in the PSBR could seriously sap confidence. Fear of unemployment cannot be so easily removed, but other fears can and should be.