Professor Meade would like to target the growth rate of nominal GDP but help relieve the debt burden by an orderly devaluation of the pound which would bring down interest rates. To ward off the inflationary dangers, he proposes fiscal measures and some form of control over collective bargaining. He singles out, perhaps unfortunately, unemployment benefits as the one item of public expenditure to cut.
The political problem with this package is that neither the Prime Minister nor the Chancellor of the Exchequer has sufficient credibility left to convince either the electorate or the markets that they could stick to such a policy over the medium run that it would be necessary to do. The Government has also clung to the mistaken theory that it is money supply which is the cause of inflation, and is therefore unlikely to pursue a steady devaluation of the pound with accompanying cuts in interest rates. Talk of a counter-inflationary stance and a mix of monetary targets has already given us a signal of this. It is not surprising that the Governor of the Bank of England has put a damper on hopes of further cuts in interest rates.
It is also unlikely that 'radical measures to limit the rate of rise in money wage rates and prices' can command the political support needed from business and trade unions. I do not prescribe to the view that incomes policies failed in the past or that they cannot be revived. But as the experience of the Labour government showed in the winter of 1978-79, much political goodwill is required for their success. The present Government is hardly the one to command such support.
The economic reality facing the Government is that, in or out of exchange rate mechanism, it has only a small room for manoeuvre. The UK cannot, unlike the US, take the path of drastic cuts in interest rates and a large depreciation of the currency without exacerbating inflationary expectations and driving long term interest rates higher.
A feasible package, given the nature of the Government and its lack of credibility, would be:
(i) Re-establish credibility by announcing a re-entry into the ERM at a central parity of DM2.50 but with wide bands of 6 per cent. This provides the only sustainable route for interest rate cuts in the future.
(ii) Ease the overhang of mortgage debt by announcing a moratorium on mortgage repayments for a period of one year, as I urged in an earlier letter (16 August). This will require a short-run relaxation of growth in M4, but at the same time ease the pressure on PSBR by bringing in extra tax revenue.
(iii) Encourage investment in capital equipment by increased capital allowances.
(iv) Relax the public control on local authority investment in housing; the extra tax revenue obtained under (ii) should make room for this.
There is no doubt that Professor Meade's proposals make a better economic package. But the manner of our leaving the ERM, coming in the wake of Mr Lawson's experiments, confine our choice to second best, if not third best, solutions. Of course we could have a change of personnel at the top and that would improve the prospects for Professor Meade's proposals. National government, anyone?
Development Studies Institute
London School of Economics
30 SeptemberReuse content