News Release
Interest Rates and the UK Economy - A Policy for all Seasons
11 October 1999
By Mervyn King, Deputy Governor, Bank of England, speaking to the Scottish Council Development and Industry, Edinburgh.
In his speech, Mervyn King answers two questions: why did the MPC feel it necessary to raise interest rates in September, at a time when inflation was a little below target and appeared likely to fall further in the next few months; and is there adequate co-ordination between fiscal and monetary policy in the UK?
He also gives an assurance that monetary policy is not set with the South East of England in mind: "But equally, it is it not set either in the sole interest of the North East of England or Scotland. It is set for the United Kingdom as a whole."
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In his text, Mr King says: "The current outlook is for continued growth with low inflation. If Britain is to retain this degree of macroeconomic stability, then there will be periods when interest rates will rise and periods when they fall. For some commentators, interest rates can never be too low. But for too long there has been a view that interest rates should rise only when necessary, and should be lowered whenever possible. That asymmetric response was a recipe for instability."
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He adds that the real test of the MPC is whether it aims continuously to meet the inflation target. For that reason, the Monetary Policy Committee must be setting a policy for all seasons. Some may say that it is all very well to set a policy for all seasons, but what about a policy for all regions, or parts of the UK? Many critics described the recent increase in interest rates as ‘premature’.
" We would describe it as pre-emptive: prompt action to head off inflationary pressures in the future and so lower the level at which interest rates might otherwise need to be set. The Scottish Council Development and Industry said that ‘Scottish business is regaining confidence after a tough period, but this announcement [of a rate rise] will dent that confidence’. Yes, it has been tough - indeed remains tough - for some industries, especially agriculture, tourism and parts of manufacturing. But there has not been an overall recession. GDP growth in the UK, over the previous twelve months, reached a trough of 1.3 per cent in the first quarter of this year, and has been rising since then. With the new quarterly data, published by the Scottish Executive, it looks as though in the year to Q1 output growth in Scotland was higher than in the UK as a whole. The latest surveys show business confidence continuing to rise. And most welcome of all, unemployment has continued to fall in Scotland, as in most parts of the UK."
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"For some time now, the high level of sterling together with falling world commodity and food prices have restrained retail price inflation. The prices of imports into the UK fell by 15 per cent over the past four years. It is inevitable that this favourable impact on inflation can only be temporary.Only a further sharp rise in sterling, and further falls in commodity prices, could maintain these rates of decline of import prices and their benign effect on retail price inflation."
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So by the time of the September meeting, much had changed from earlier in the year. New data showed that final domestic demand - that is spending by households, governments and business on consumption and investment - was growing faster than expected. The data on the housing market - for the UK as a whole not just the South East - as well as credit indicated that the strong consumption growth over the past year might persist. And house prices, I should add, enter our decisions because of their implications for future consumption, not because we are trying to target house or indeed any other asset prices. Unemployment was still falling: the Labour Force Survey measure of unemployment had reached its lowest rates since the series started, while the claimant count had fallen to its lowest level since 1980. The Bank’s regional agents had also noted tightness for both the skilled and the unskilled. Oil prices had risen sharply during the year. These factors led a majority of the Committee to vote for a modest rise in interest rates."
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Mr King says that the high level of sterling has undoubtedly caused serious problems for many sectors of the economy. As a result, some critics have argued that raising taxes or cutting public spending would enable the MPC to lower interest rates, thus bringing down the pound. There is, it is alleged, a failure of coordination of monetary and fiscal policy.
He says "It is costly to change taxes and government spending frequently. Changes in tax rates can distort the choices of the private sector and lead to a misallocation of resources. To raise and lower public spending at short notice can disrupt the provision of public services. And there are inevitable legislative and administrative lags in implementing quickly changes in tax rates and government spending. Tax rates and public expenditure should reflect long-run priorities of the elected government, and are not well suited to frequent changes. Since the MPC first met in June 1997, it has raised interest rates on six occasions, lowered them on seven occasions and left them unchanged sixteen times. It would make no sense for a government to try to change tax rates with that frequency.
.....It is no part of the Government’s responsibility to try to make life easier for the MPC by manipulating fiscal policy to manage the economic cycle. What matters to the MPC is the overall fiscal stance, and that it remains on a sustainable basis. Decisions on that are made once a year in the Spring Budget. In the UK, co-ordination between monetary and fiscal policy works well."
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".... So perhaps the fate of the MPC is, rather like dentists, to perform an important service but one which does not make people happy. Regular monitoring and early treatment, while rarely pleasurable, prevent more unpleasant symptoms later. So it is with a pre-emptive monetary policy."
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