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Britain's economy needs to cool Samuel Brittan The Financial Times 27/05/05 Fashions in monetary policy change rapidly. Only a few weeks ago the argument was about whether to increase British short-term interest rates. Indeed, as recently as May 9, one member of the Bank of England's monetary policy committee, Sir Andrew Large, was still voting for an increase. Yet the general tone of discussion has now changed towards the topic of how far and when rates are likely to fall. The reason for this is the slowing down in the growth of UK real gross domestic product. Official figures show a slowdown to an annualised 2 per cent in the first quarter; and estimates by the National Institute of Economic and Social Research show a further slowdown to 1.6 per cent in the quarter ending in April compared with over 3 per cent in 2004. Consumer spending seems to be marking time. It does seem clear that, for all the denials, consumer spending was boosted by rising house prices and "equity withdrawal" - in other words, consumer borrowing on the strength of property values. You do not have to predict a draconian fall in house prices to see that this support for demand is likely to be weak or absent. If it were both desirable and feasible to maintain a stable quarter-to-quarter growth rate in line with trend, then there would undoubtedly be a case for early reductions in short-term interest rates. In his dissent, Sir Andrew mentioned "households' persistently rapid accumulation of unsecured debt" and stronger-than-expected inflation outcomes. The Organisation for Economic Co-operation and Development suggests that the British economy is operating "at, or slightly above, capacity"; so it needs to cool off. I would also emphasise our old friend the balance of payments. This is the first time in many years that I have based any policy recommendation on this archetypal British fear. I have usually urged a policy based on sound domestic finance and allowing the exchange rate to take the strain on the external front. But it is one thing to avoid silly policies based on balance of payments fears and another to advocate policies that would prevent any improvement. The British situation is different from that of the eurozone, where the OECD has just recommended a 0.5 percentage point interest rate cut. The eurozone has a balance of payments surplus; and its underlying growth rate has been much lower. Andrew Smithers, the City economic analyst, has convincingly argued in his April 22 report that the UK economy has similar weaknesses to the US one. On the official figures the UK has a current account deficit of around 2.2 per cent of GDP. This reflects an anomaly in the treatment of earnings from direct and portfolio investment. If these were treated in the same way, the deficit would be more like 3.2 per cent of GDP, admittedly less than the US deficit of 6 per cent, but not something that overseas investors can be counted on to finance indefinitely. I am not arguing for any piece of fine-tuning to narrow the payments gap. I am merely saying that if natural forces lead to a modest hole developing in the British economy, the Bank should not rush to fill it up with domestic demand, but leave room for an improvement in the balance of payments that might occur spontaneously, for example, from an appreciation of other currencies or any upsurge in world activity. How long should we continue to neglect any weakness of domestic demand? There could come a point when there is obviously more than enough spare capacity to sustain any feasible improvement in the balance of payments and creating more would be sheer masochism. To paraphrase a frequent misquotation from Keynes, "If the facts changed, I would change my mind". But they have not yet done so. There is another aspect. Gordon Brown, the chancellor, has boasted about 51 quarters of consecutive growth since mid-1992 - some of them, of course, under a Conservative government. Nicholas Crafts, a distinguished economic historian, queried the validity of this criterion on this page (April 13). He believes that annual data are more instructive than quarterly ones - if only because they go back much further. On this basis the period since 1992 has not matched 26 years of continuous growth from 1947 to 1973. It is true that this was a period of "stop-go", when considered quarter by quarter, but the downturns were brief and allowed year-to-year growth to continue. The electorate probably values stability above rapid growth. But an attempt to maintain unvarying quarter-to-quarter advances risks putting the economy into a straitjacket and is at variance with the "flexibility" that the chancellor normally preaches. The last MPC minutes showed clear divisions of opinion. In contrast to Sir Andrew, some "doves" were clearly itching to get interest rates down. They should constrain their impatience and remain in the dovecote.
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