Leading Article: The Threadneedle Street option

GOVERNMENTS obliged to bend to the winds of a crisis tend subsequently to claim that they have not been blown off course. That was one line emerging from yesterday's Cabinet meeting. In several respects it was true. Interest rates were back at 10 per cent. Norman Lamont's strategy had been given a unanimous endorsement: there was no question of him resigning. Reducing inflation continues to be the Government's stated priority. Yet in one essential respect everything had changed with the Government's humiliating withdrawal of sterling from the exchange rate mechanism, and the pound's effective devaluation by some 10 per cent.

Yesterday's Cabinet agreed that sterling should rejoin the ERM 'as soon as conditions allow'. That target will itself inevitably be disputed by the Euro-sceptics in the Conservative Party, the more vigorously if the French say no to Maastricht on Sunday. Even if the party as a whole rallies behind it, there will be endless debate about when the time is right for re-entry. But the Cabinet's decision is correct. The arguments that favoured entry two years ago remain valid.

Long experience has shown that, in Britain at least, there is no easy way to reduce inflation while encouraging economic growth. In this country almost every conceivable permutation of policies has been tried. Successive governments have tended to take risks that encouraged inflation in order to stimulate growth and reduce unemployment. In the present instance, the Government over- reacted to that tendency, defending an exchange rate that proved indefensible with interest rates that deepened the recession.

The goal remains valid, but the Government's credibility has been severely damaged. There is one method of restoring faith in the policy, and that is by making the Bank of England independent. For all that the president of Germany's Bundesbank helped trigger the present crisis by talking too much, it is in large measure thanks to the Bundesbank's independence and anti-inflationary record that the mark has achieved its ascendancy while the German economy has remained dynamic.

The primary task of all central banks is to defend the value of the currencies they issue bearing their name. If they enjoy independence, they can pursue that goal largely immune from the political pressures to which governments are prey. The record shows that independent central banks are better at achieving and defending low inflation: the US Federal Reserve is a case in point, and in Canada and New Zealand the trend has been to grant greater independence. An independent, or at least considerably more independent, Bank of England would give a new credibility to the management of sterling not just while the pound floats, but when it re- enters the ERM. However heatedly politicians debated the correct level for interest rates, Threadneedle Street would decide.

The change would require an Act of Parliament. The Bank would, like the Bundesbank, be obliged to support government policy: it could not divorce itself from the political environment, and it would have to be accountable to Parliament. Such an institution, wisely run, would create a very different set of expectations and inspire confidence among people disillusioned by the record of successive governments.