Letter: Tight money

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Tight money

I AGREE with Gavyn Davies's overall conclusion that the Budget was a step in the right direction (Business Comment, 23 March), but on three points he overstates his case.

First, he criticises the Bank of England's "puzzling failure to pursue a firm domestic monetary stance since the election". In fact, the Bank did raise interest rates steadily last year, resulting in real short interest rates of around 41/2 per cent at present, which is high by historic standards. Added to the continued strength of sterling, monetary conditions are now quite tight and will act as a significant drag on growth this year. This has added to the risks of a hard landing and it is heartening, rather than puzzling, that the Bank is taking this risk seriously in weighing up the case for a further rise in interest rates.

Second, he argues that the failure of the significant fiscal tightening introduced in the July 1997 Budget to slow domestic demand "should be a salutary lesson to staunch believers in fine tuning". In fact, this can be attributed both to lags in the system and the fact that the fiscal tightening, although large, was not well targeted on the consumer.

Third, he states that "cuts in corporation and business taxation are intended to boost the level of business investment in the UK", which the Treasury has rightly said is inadequate. In fact, the net effect of the 1998 Budget will be to raise the corporate tax burden from next year by around pounds 1bn per annum. This comes on top of the removal of dividend tax credits for pension funds last year, which increased the corporate cost of capital. All these measures, although justifiable from a long-term perspective, will tend to reduce total UK corporate investment over the next few years. By further encouraging share buy-backs, they may also have added to a share price bubble that looks increasingly unsustainable given the recent slowdown in corporate profits growth.


Head of Macroeconomics

Coopers & Lybrand

London WC2