The Bank of England tightens money further

Over a year ago the Bank of England decided to tighten money policy considerably. It removed all the special credit lines for commercial banks designed to encourage lending. It issued stricter guidance over car loans, mortgages and consumer credit. It went on to raise interest rates from 0.25% to 0.5%. It achieved its aim, with money growth halving to just 3.5% from the 7% level in 2016. The car market duly fell sharply, and the top end of the property market was damaged, primarily owing to tax rises, but assisted by the credit tightening. Money and credit still look too tight to provide the backdrop for decent expansion.

Yesterday they decided to go further, by increasing interest rates to 0.75% and introducing the concept of an Equilibrium rate of interest considerably higher than today’s rate to guide markets towards expecting more monetary tightening. It is difficult to see why from the  numbers being reported. Growth has slowed. There is no surge in inflationary pressures. Banks are better capitalised. On the Bank’s own forecasts the UK economy grows more slowly than it used to with no inflationary problems ahead. They themselves concede that if they kept interest rates at the new level of 0.75% instead of raising them further prior to 2020,  output would be higher, unemployment lower, and inflation only 0.2% higher than on their preferred course of slow growth and more tightening by that date.

The Equilibrium rate is an unhelpful abstraction or distraction from the day job of keeping inflation under control whilst promoting better growth. The Bank accepts that the so called Equilibrium rate “cannot be directly observed” – a polite way of saying it does not in any normal sense exist. They accept that “there is a wide degree of uncertainty around the estimated level” of the real equilibrium rate. By choosing a range of 0% to 1% real they are trying to get markets to accept more tightening, but then they back off a bit by leaving the timescale imprecise.

Inflation is being kept down by the open nature of the UK economy. A large inward migration is keeping wages down, whilst massive imports of goods and services are keeping general prices down. The Bank forecasts those features to continue. They are aided in this by internet competition, and by the emergence of big discounters in a range of markets. The Governor himself gave a good lecture some time ago which I commented on effectively debunking the main part of the MPC’s analysis. Their theory is  that they can measure capacity, and that we are  now close to capacity. They therefore expect inflation to rise as we hit capacity.  As the Governor pointed out, in an open global economy like the UK you can always import anything you need which domestic output cannot  provide. So why is the MPC still praying in aid the idea that we will soon have exceeded capacity, and therefore need to be reined in?  How do you measure capacity reliably these days, when the internet and changing consumer fashions and transforming what we need and the supply to meet demand? The Bank is doing us no favours by being too pessimistic about the outlook and then taking action to ensure a disappointing outcome.

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What happened to the record temperature?

A week or two ago the media was full of stories of an exceptional heat wave that would take temperatures to new records.  We were told that we should expect drought and intense heat. A few days on and temperatures  slumped, with plenty of rain over the weekend. There has been little news reporting of the change of weather, and  no pieces apologising for getting the forecasts wrong about new records  by last week end. If as expected temperatures pick up again and there is no more rain we might hear about that.

I thought at the time of the forecasts  that the weather was more like the weather in dry hot summers I remember in the past, so I looked up some of the figures. According to the Met Office 30 year numbers the average summer temperature has been 14.3 C and the average rainfall 241 mm. Every summer in the last ten years save 2013 has been wetter than the 30 year average,  with 2011, 2012 and 2015 cooler than the average. 1976 was clearly much drier and hotter than recent years, as were some summers prior to that.

After the recent hot spell the highest temperature records for 1976, 42 years ago, remain intact. 2003 also recorded a high temperature for Faversham in 2003 which some say was slightly higher than 1976 for England.

Many things influence the weather, making it difficult to come up with a reliable model which accurately predicts what might happen next. Wind speed and direction changes, water vapour content in the air alters, cloud cover is  very variable, solar activity alters in intensity, the jet stream moves around.  Short term weather forecasting has got better because the experts have greater visibility of clouds on their way to us, and can calculate from wind speed and direction what is likely to happen. As any sailor can tell you, however, the wind is very  variable minute by minute. altering the course and pace of clouds across our landscape. It is even more difficult making a long term forecast when the clouds which will dictate so much have yet to be formed.

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Project Fear from the EU is just absurd

I guess much of the latest round of Project Fear, now in its extreme phase, comes from EU sources. They are clearly worried that we might just leave without making them a large payment and without staying in their system for another 21 months. They seem to be  trying to shock UK public opinion into buyer’s remorse on Brexit. Their efforts are silly.

Doubtless some of the most ardent Remain MPs and peers, many of them on the Opposition benches, seek to play up any negatives the EU might throw them as they seek to disrupt the country and its government over Brexit. The latest scare stories do not merit the attention they get in some newspapers and in some of the media. A cursory questioning of any of these  stories would show it is without substance.

Let’s take the latest scares that we will run out of drugs and food. How could that possibly happen? Continental suppliers want to sell us their goods after March 29th 2019, as they do now. The EU does not have the power to ban them selling to us. We will control all the ports for the receipt of these goods, so we will decide what checks and payments will be required. We can appoint whatever people and deploy whatever technology we want to ensure smooth running of the import process under WTO rules. Why would we want to introduce new checks and taxes that make it difficult to import things we want?  I was glad to see that No 10 has at last  briefed that there are no stand by plans for the army to move food, as food will of course continue to roll in on ships and trucks as it does today. Our non EU imports come in smoothly at the moment showing we know how to do it, even with tariffs where the EU requires them.

Or lets examine  the stupid idea that France and Germany will ground all their plans that currently fly to the UK in order to stop our planes flying to their airports. They are not going to want to cut themselves off from the UK market, from London and the large international hub at Heathrow, and their airlines will not want to have to cancel all the tickets they  are selling for flights after March 29th 2019. The EU does not have the power to stop planes flying between member states. What would they say to the Spanish co owners of BA if they wanted to damage  BA, the main UK airline? How would they put up a case in court when an airline sued them for attempted damage to its business?

Then there is the wrong  notion that EU citizens living in the UK and UK citizens living in the EU would be at risk of removal. The UK has made clear it is  not going to ask people legally settled here under EU rules to leave, and I expect the rest of the EU to behave in the same manner towards UK people living on the continent. Advanced democratic countries obey international law, which does not permit mass deportations. Nor I am glad to say have I ever heard a mainstream UK or EU politician advocate anything so unpleasant.

During the referendum campaign when I was speaking to a public meeting in my own area, the Remain spokesman was a civilised former senior civil servant. He delivered a mild version of Project Fear about the job losses, recession, falls in house prices and the rest that his side forecast for the winter immediately after the vote. We  now know that was all wrong. The public reaction in a mixed audience was fascinating. They laughed at the silliness of Project Fear.

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Let’s spend the EU exit tax on ourselves instead – that’s a £39bn boost to us all

Here’s a paradox. Ask the UK Treasury for money for schools or social care or defence and they say there isn’t any. Ask the Treasury for more money for the EU, and they say how much would the EU like?

Here’s a popular policy. The PM should tell the Treasury that the £39 billion they say we can afford to give to the EU should be spent at home instead. Let’s leave in March 2019 with no leaving present to Mr Juncker and his friends.

With £39bn to spend we could

Increase the NHS spend as planned – as long as we control what the money goes on and secure more quality and capacity with it

Sort out social care, offering £2bn a year more for that

Strengthen our armed forces

Increase schools spending

Give everyone a Brexit  bonus by cutting Income Tax rates

Give business a boost by cutting business rates

Collect more revenue by cutting CGT and Stamp duty rates which are too high

The reason the UK economy is growing more slowly than the US is they have supportive tax cuts and spending boosts, and helpful authorities who are promoting growth.

I wonder why the Uk Treasury rejects that model? And why does it only have money for the EU, which we are meant to be leaving?

If we left on WTO terms we would also have the £13bn of new tariff revenue. That should also be given back to us as tax cuts.

Spending the £39 bn at home means we can have tax cuts, domestic spending increases and less state borrowing. Why doesn’t the Treasury demand this?

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Going for faster growth – how the government can help

Growth mainly happens thanks to free enterprise and the opportunities of the market. Governments can help at the margin, and can hinder in so many ways if they follow anti enterprise policies.

I have been arguing in recent posts for two straightforward ways the government can help. It can spend more on items like transport capacity and education which make a direct contribution to a more productive economy. It can cut taxes that get in the way of enterprise and impede work.

In more detail, the government should take advantage of our exit from the EU to give UK competing businesses more scope to win government contracts. Strict application of EU procurement rules in the UK has meant the public sector buys many cars, machines and other supplies from continental producers. Who sees the French or German official buying a UK made car?  A new Uk system should of course encourage competition to ensure innovation and keen prices for taxpayers,  but it should also be friendly to competitive UK based businesses. We have started to demand more UK content in rail procurement for example, and have used the exemptions in the EU scheme to allow UK provision of much of our defence equipment in areas like naval vessels.

Intelligent buying by government can commission product for UK purposes that could also have an export benefit by selling the same or similar to overseas interests.

The UK needs to have a sensible approach to new borrowing. Borrowing huge sums for a large project like HS2 which is unlikely to generate revenues to service it is not sensible. Borrowing lesser sums  at  very low rates in the public sector today to build more cost effective road and rail capacity would be sensible. UK state debt is under good control when you adjust the totals for the £435 bn the UK state has bought in and owes to itself.

The best thing the government can do to promote growth is to cut tax rates on work and enterprise. The next thing it can do is to use the money it raises in taxes to employ people at home and provide services and incomes here instead of sending it to the EU.

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Getting the economy growing faster

The combined policies of a fiscal squeeze – eliminating the deficit – and monetary tightening – cutting back on car loans, mortgages and consumer credit – has predictably slowed our growth rate in recent months, as forecast here. Last year the government produced a budget where the deficit undershot by £19bn over the course of the financial year. The Chancellor could report much faster and better progress with cutting the deficit, but in so doing took more money off us in tax than planned which helped slow the economy.

If  he had   spent all the £19 billion on a mixture of lower taxes and higher spending as identified in recent posts, there would have been up to  a 1% boost to output. This in turn would have generated more revenues, allowing the deficit to come down a bit  as well.  The good news is this would reduce the amount of extra borrowing  a bit more. The amount we borrow is quite sensitive to the pace of growth of the economy. When growth speeds up more revenue comes into the Treasury from people earning and spending more. As more people get into jobs, so the cost of their benefits goes down.

The UK economy has the potential to expand at more than 2% per annum, so we should be aiming to boost its current growth rate which is  below that level.


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Raising productivity – a policy all claim to like in general

If we work smarter we can be paid more. That is the simple message  behind the economists’ idea of raising productivity. Today there is plenty of scope to do just this. Robotics, the digital revolution, powerful computers all allow an individual at work to have more machine power at their elbow. More of the drudgery can be done by machine, leaving individuals to do the more interesting things that require talking to clients and customers, making decisions about product and output, and organising production.

The area of the economy that has been most disappointing in the last 20 years for productivity growth has been the public sector. Of course we want quality to rise, and do not wish to scrimp and save on teachers or doctors. That still leaves plenty of scope to run the NHS or the education system more effectively. Quality and efficiency often assist each other. High quality means less waste, getting things right first time, doing things well in a way which  maximises the use of resources.

The productivity problem lies behind why the government must ensure in its directly managed NHS that it gets good value for the extra money. Some of the money should be spent on systems and digital age equipment which makes it easier for trained staff to do their jobs and helps them control and audit the quality of what they do.

Those who see productivity programmes as excuses for cuts and less spending need to be reassured that proper productivity programmes create more worthwhile work, and go with the grain of all staff who want to raise performance.

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Growing faster – cutting taxes on transactions

The government has developed a bad habit of increasing taxes on transactions. It now penalises people heavily if they buy an expensive new car. It hits anyone investing in rental accommodation for others. It penalises anyone who buys an expensive home or who needs a second home to help with their work or provide for their holidays. High Stamp duties have cut the volume of property transactions, and high VED has helped slash the purchases of new cars.

It is doubtful these tax rises have produced additional revenue. Clearly lower volumes of transactions reduces revenue, though there are some offsetting gains from charging much more on the transactions that survive. There are also hidden tax losses. The property taxes mean less Estate agent and conveyancing income, less turnover for removal firms, less business for builders, decorators and home designers serving the needs of people moving and wishing to adapt their purchase. As car sales fall so there are losses of turnover and profit for car businesses.

The government should review its current transaction taxes and seek to find a level which does less damage to turnover and related activity. Cutting the duties would increase total revenue, and might even increase the revenue from the turnover taxes themselves , given the penal levels some now run at.

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Growing the economy faster – cutting taxes on incomes

Government try to persuade us that they tax us to stop us doing things they think get in the way of a good life or damage the environment . So they single out smoking, drinking, driving and other conducts they do not like for taxes in the hope it will deter or reduce our activity in the penalised area. Those same governments claim to support work, and think work is good for us and for our neighbours who benefit from the work we do. So why then do they tax work so much?

They say they do not mean to deter us from working, but point out they need the money. They have to tax good things as well as bad things. They then claim to want to tax them in a way which wont be too damaging – unless they take a socialist position that high paid work is immoral or wrong. I agree that work is generally a good thing, providing incomes for people and interest to their lives. Many people get a sense of achievement  out of producing goods and services others want, and enjoy some of the social contact that the workplace provides.

Under the Coalition the government recognised the need to make work  more worthwhile, and did so by concentrating on taking more low income earners  out of Income tax altogether. Today the Conservative government has choices. It could do more of that, or it could cut the rates. There is something to be said for rate cutting. If the marginal rate comes down working more is more worthwhile. Well done it might even  bring in more revenue. Cutting the 45% top rate to 40% would tax the rich more – the cut from 50% to 45% as predicted here did bring in considerably more revenue. Cutting the 20% rate in stages to say 17.5% would provide a boost to most incomes in the country, increasing spending and activity. It too might boost revenue overall, when taking into account the extra revenue from VAT and other duties placed on transactions.

The USA, Italy and France are all going for tax rate cuts. The US economy is growing faster as a result, and the French economy is also doing a  bit better. We need to catch up with tax cutting, so we do not become uncompetitive.

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Spending and the case for social care

The government is currently looking into how we provide and pay for social care.

Today we have a mixed scheme. The general principle behind it is if someone needs meals and housing, these are  normal costs they should pay for out of their incomes and pensions. If someone needs medical treatment or a stay in hospital, this is something that comes free under the NHS guarantee.

If someone needs help at home with everyday activities then they have to pay. If they are on a low income with few assets then the state pays. The value of their home is not taken into account when working out if they can afford the home care.  If someone has to go into a care home then they have to pay if they have income and assets. The state pays when the assets have largely gone. The  value of their former home is part of their assets for this purpose, and they have to sell their former home to pay for the care home. Of course if they have  a partner that still needs to live in their own home this does not apply.

Some think this is unfair, as it means if an elderly person needs to go into a home they lose their home and its value if the fees so require. Conversely if an elderly person can stay in their own property, they keep the asset and get more help with the care costs if on a low income.

I do  not think we should change this general approach. It would be too dear to offer people free care home provision so they can leave their former home to their children, whilst it would be too tough to demand people living in their own homes to have to pay a levy on the price of their home. No political party has come up with a popular way of making this fairer and easier. Some have suggested taking some of the value of the home for the person continuing to live in it, by way of an additional death tax, whilst putting some cap on the amount of the  value of the former home someone needs to spend on care home fees. I would be interested in views on it,  but still think it too difficult to sell the idea of what will be called a new death tax over and above IHT.

I want some additional money to increase the quality and quantity of social care, for people of all ages and disabilities. Better care is a good in its own right, where many of us are happy to make a contribution through taxation. It will also reduce more strain on the NHS by getting people back home more quickly after hospital treatment.

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  • About John Redwood

    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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