Why the big zero is Mr Major's latest big idea

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The Independent Online
USUALLY when politicians say they are not going to devalue, one can bet on the fact that they will. . So the financial markets' response to such a declaration by both the Chancellor and the Prime Minister at the beginning of the week has been to sell the pound. But this time they may be wrong, for John Major really believes that maintaining the value of the pound in the exchange rate mechanism is the one way of getting inflation down - not just to the 2 or 3 per cent that people remember from the Fifties and early Sixties but to zero.

Why is he so set on zero inflation? Quite aside from believing that it will never happen, many people seem to like a little inflation. Home owners imagine that they have cleverly made a profit on their houses; business people find it makes life easier if they can slap another few per cent on the price of their products; wage earners like getting pay 'increases' even if inflation leaves them no better off; and, in the past, governments have liked inflation because it cuts the real value of the national debt.

Yet on Monday, the Prime Minister said again that he hoped to have zero inflation by the next election. One might dismiss this as a misguided attempt to strengthen sterling before tomorrow's Bundesbank council meeting, which may put German interest rates up. But to see Mr Major's views on inflation as the standard politician's rhetoric is to misunderstand the game he is playing. It is a very long game, and a politically cunning one.

There are at least three reasons why Mr Major wants to kill inflation. One is that he was a banker for longer (1965-1979) than he has been a member of Parliament. His formative years were spent handling other people's money, a quite different discipline from that of most MPs. One experience from this period must still loom large. In 1976, Mr Major went as press officer for Lord Barber, then the chairman of Standard Chartered Bank, to the International Monetary Fund meeting in Manila. That was the meeting which Denis Healey, then the Chancellor, never reached, having turned back at Heathrow when he heard that there was a run on the pound. Eventually, the pressure forced Britain to go to the IMF, agree cuts in public spending and raise a loan.

Those who were there will recall an evening at the British embassy in which the mood was one of bleak national humiliation. The feeling among the small group of visiting Britons was that we could not keep going cap in hand to the IMF and would have to learn to manage our affairs like a grown-up country. That sense of failure led directly to the establishment of monetary discipline and indirectly to the election of the Conservative government two and a half years later.

That feeling still exists, though Mr Major now places the emphasis on national competitiveness. He argues that it is an intolerable handicap for British companies to operate under higher inflation than their competitors.

His second motive for destroying inflation is that the supposed short-term advantages it carried have all but disappeared. In the Nineties, the sophistication of the international capital markets renders even short-term gains illusory. There is a clamour at present for sterling either to be devalued within the ERM or to leave it, and for the Government to cut interest rates. While the Government still has the power to devalue sterling, and might even be able to cut short-term interest rates for a while, to do so would certainly increase long-term rates, which are determined by the inflationary expectations of the international money markets.

Long-term rates have become more important in determining the cost of capital to business than short-term ones, for they affect not only the price at which companies can raise long-term loans but also share prices, which affect the cost of issuing new equity. This crucial point was recently made by Professor Mervyn King, chief economist at the Bank of England and one of the few world-class economists in Britain. Bankers understand this, but, alas, a lot of theoretical economists, not to mention many MPs, do not.

The third reason for Mr Major's passionate opposition to inflation is a politician's reading of what voters want. There has been a change in how inflation is regarded, as measured by the British Social Attitudes survey. In 1983, 52 per cent of households were concerned about inflation; in 1990 that had risen to 70 per cent. If one mistrusts opinion polls, one can look at demography. As the population ages, a larger proportion of voters will either be retired or be approaching retirement. By 2000, 22 per cent of the population will be over 60. The retired have a vested interest in seeing their savings protected.

So in thumping out the zero-inflation message, Mr Major is also responding to a political mood, even though he may be a little ahead of the electorate. Many people who bought their houses in the late Eighties want a little inflation. But the experience of the two main parties since 1979 is surely that it is safer for a politician to run ahead of the electorate than to be seen scrambling to catch up.

In other words, going for the big zero not only gives the people what John Major, as a politician, judges they want. It also differentiates the product the two parties are offering, helping to make Labour seem old-fashioned. Whether, of course, zero inflation will be delivered is another matter, but the fact that Mr Major has made it one of his big ideas is not just realistic economics but also smart politics.

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