First, Gordon Brown smashed the Bank of England’s ability to understand the money markets by removing their duty to regulate the day to day activities of the commercial banks, and by removing their task of raising the public debt.
Second, he set up a so called independent Monetary Policy Committee. Every member of it was either appointed by the Chancellor, or by someone appointed by him. We have not been told how they were selected, and why some were renewed and some were not. The Committee was given an easier target to hit in December 2003 at a time when they should have been putting interest rates up. They were effectively told to cut rates recently as part of a concerted international move. In late October the Chancellor effectively instructed them to cut rates again, whilst intoning that they were still independent!
What he should do instead is write a new letter to the Governor. It should say:
I realise the conduct of money and banking policy has gone badly wrong in recent years. On reflection, I think the Bank does need to regulate the commercial banks and to handle government debt issue, so it is hands on in the money markets as it used to be. I therefore intend to restore these powers as soon as possible. I believe Parliament will welcome this move. We need a strong Bank which is close to the needs and misdeeds of commercial banks, so that it can correct and adjust more rapidly.
I would like to continue with a more independent Monetary Policy Committee. This will require a more independent approach to appointments and renewals. I am considering giving the Treasury Select Committee of the Commons a role in this process. However, recent events have also shown that there is merit in the US system where the Fed has a clear duty to consider output levels as well as inflation, and where it is required to work in a way which is compatible with the Administration’s policy. I will be consulting interested parties on how we can get this balance right. I have no wish to stifle the views of a genuinely independent MPC, but there may be occasions as when we agreed emergency rate cuts with other countries where the government does have to override. This should always be done in a transparent way, with reasons being given for the use of the reserve power.
It is perhaps too early to go into who is to blame for the sharp move from excess credit to credit crunch, as we need to manage the situation day by day at the moment. However, I do hope the MPC is asking itself how it came to set rates that were too low for too long, leading to inflation rising to 150% above the target rate. I also hope it will ask itself urgently whether rates are now too high for the deflationary situation we find ourselves in.
For my part I do accept the public sector cannot spend our way out of this recession given the state of the national finances. I fully understand that if we seek to borrow too much the strain will be taken on sterling and the longer term rate of interest. These market pressures will constrain me in my judgements about spending.
At the same time as carrying out this necessary reform the Chancellor needs to take other action..
What could they do?
1. Cut interest rates. Convene an emergency meeting of the MPC if they want to persist with the fiction that they are in charge, and don’t let them out until they see sense and back Mr Blanchflower.
2. Revisit the banking share package. Tell Lloyds to raise its own money anyway it sees fit. The taxpayer should not finance the merger. Sort out with HBOS and RBS a package which is fairer and lighter on the taxpayer, making them raise more of their own capital and cash by cutting costs and expenses and conserving more of their own cashflow.
3. Start to get more control over public spending, and give us revised forecasts of public borrowing which are credible and show a wish to get on top of the government’s own growing debt mountain.
4. Sort out the statements of the UK authorities. They should be sober rather than apocalyptic, and should concentrate on what is being done to tackle the problems of banking liquidity and capital, overborrowing and government indebtedness.
5. Produce new forecasts of the economy so we have a better idea of what the authorities really think about the length and depth of the recession they are now calling.
6. Work with the banks to get maximum benefit from the £400 billion plus package of loans, guarantees and money market assistance. The money needs to be supplied however it does most good to get banking markets working again, with proper security for taxpayers.
7. Deliver on the promise to pay all government bills within 10 days.
The magnitude of the UK debt problem is large but it could be manageable. UK households have borrowed around 100% of National Income. UK companies have been more restrained, borrowing maybe half National Income. The government owes somewhere between half and more than 100% of National Income depending on whether you include pension debts in the government total. If we take as a very rough figure total borrowings and liabilities of say £3.7 trillion, the interest burden is still manageable. At 5% interest it works out at around one eighth of income, and at 10% at a quarter. Lower interest rates enforced in the market would clearly ease the pressures.
The danger for the government is that the interest burden on state borrowing will rise too quickly. This downturn began because the authorities decided they needed to reduce the total amount of private sector borrowing. The authorities decided to tighten the squeeze by demanding banks hold more capital for a given level of lending. It would be odd to end up simply transferring the excessive borrowings from private to public sectors.
In the Budget the government forecast £43 billion of public borrowing this year. Most forecasters now expect this to be around £65 billion, given the extra commitments added and the decline in tax revenues.
We need to add to this the £37 billion they plan to spend on buying banks shares. We also need to add the £18 billion they are borrowing to finance the cash and guarantees they have given to Abbey Santander to get them to take the deposit liabilities of Bradford and Bingley. The government has put an extra £3 billion capital into Northern Rock.
This adds up to a huge £123 billion of extra borrowing this year. That’s £2050 each for every man woman and child in the country.
Starting borrowing requirement £43b
Extra spending and reduced revenue in year £22b
Bank shares purchase £37b
Bradford and Bingley £18b
Northern Rock extra capital £3b
This is too much, and represent too big a risk for the taxpayer. The government needs to cut this, in order to maintain the country’s credit rating and what is left of the value of our currency.