Howe's brave move
Tim Congdon
When the increase in Minimum Lending Rate from 14 to 17 per cent was announced on the floor of the Stock Exchange last Thursday, it was greeted by a burst of cheering. The market seemed enthusiastic about the latest achievement of the British economy, the highest interest rate levels ever recorded. The incident recalled George Orwell's remark that the most stirring battle-poem in the English language is about a brigade of cavalry which charged in the wrong direction. The Government has decided to make credit more expensive just as the signs of an imminent recession are becoming alarming and insistent. Does it realise what it is doing? Is it taking the right steps to bring the economy under control?
In fact, 17 per cent MLR and Sir Geoffrey Howe's minor package of measures have a basically conservative intention — to ensure that the financial goals set in the June Budget are met. The two central targets are for the public sector borrowing requirement and the rate of money supply growth. In June, the PSBR objective was £8.3 billion in the present financial year, while the money supply (as measured by sterling M3) was to increase at an annual rate of 7 to 11 per cent in the ten months to mid-April 1980.
Before the Government acted, both targets were in jeopardy. The likely PSBR outturn had been revised upwards to £9 billion and in the four months to mid-October sterling M3 climbed at an annual rate of 14 per cent, much above the top end of the desired range. In the limited sense of restoring the credibility of the official targets, the Chancellor's measures have already worked. By calling on the oil companies to accelerate a £700 million payment of pet roleum revenue tax, the PSBR has been neatly reined back to £8.3 billion. On the monetary front. 17 per cent MLR acted as the catalyst for mammoth official gilt-edged sales, amounting to about £1.75 billion in two days. This will reduce money suPPIY growth in the November and December banking months, and should guarantee that sterling M3 is brought back to the straight and narrow of 7 to 11 per cent. It is over the broader question of how the economy will respond that most concern has been expressed. While the Government has been cultivating its monetarist garden the unions have stampeded over the wide. open range of collective bargaining. There have been many pay settlements of the 16 to 20 per cent order and, since commodity prices have also been rising, inflation threatens to approach 20 per cent by the end of the year. Assuming that money supply growth is lowered beneath 11 per cent, a big gap will he opened up between the rate of monetary growth and the rate of price increases. The implication is a severe tightening of liquidity constraints throughout the economy. as companies and individuals find themselves short of cash, to be followed by an intensification of recessionary pressures. One does not have toconsult a clairvoyant, or even and economic forecaster, to see that 1980 will be a year of falling output and rising unemp loyment. . But the question is whether the Governts-. ment had any alternative to adhering to original targets. The economic outlook has deteriorated in three ways, compared to the Government's expectations in June. First, the pay round has been disappointing. par ticularly ,e as the strength of the pound on tn foreign exchanges for most of 1979 should have been a constraint on wage claims in companies exposed to foreign competition. Secondly, the demand for bank credit from the private sector has been irrepressible, despite interest rates which; even before 17 per cent MLR, were at almost unprecedented levels. Finally, the turmoil in Iran cut off another 2 to 3 per cent from the world's supplies of oil and added another 10 to 15 per cent to its price.
The Government could not, without inconsistency, have both allowed this situation to continue and persisted with its rhetoric about preventing inflation by monetary means. By raising MLR to 17 per cent it has refused to accommodate any inflationary push. Of course, the downturn in business activity next year will now be worse, but ministers can reasonably argue that it is not their fault. When Sir Geoffrey Howe announced the 7 to 11 per cent money supply target five months ago, he said that wage increases above that would cause trouble. Many companies promptly came up with 17. per cent pay offers to appease their unions; they will be punished next year by severely eroded profit margins and lost market share; they are learning (as management . already has in West Germany) that it is for the good of their shareholders and employees if wage increases are determined by money supply targets, not by inflation forecasts. It goes without saying that the lesson would have been pointless unless the Government had demonstrated that its stated target is its actual target and that it will not be bullied by unfavourable financial trends.. Perhaps the most reassuring aspect of Sir Geoffrey Howe's measures is the commit ment to slowdown credit expansion solely by the market mechanism of high interest rates, and not by crude administrative controls such as hire purchase or credit card restrictions, In consequence, it is the building societies which will bear the brunt of last week's package. Their deposit inflows were insufficient to maintain present levels of mortgage lending when MLR was at 14 per cent. They are now hopelessly uncompetitive and will have to raise their rates substantially, with obvious repercussions on mortgage payments, personal sector borrowing and in due course on house prices. Something had to be done here, as the 50 per cent rise in house prices in the last 18 months had given impetus to credit-hungry inflationary Psychology. But it is a welcome surprise that the corrective should have been administered by a Conservative government, traditionally so friendly to the owner-occupier. 17 per cent MLR will educate the public into a better appreciation of how antiinflationary policy works. It may, like the Charge of the Light Brigade, have been unnecessarily braVe, but it was not a move in the wrong direction. The cheers in the Stock Exchange were not altogether ironic in spirit and may eventually prove to have been well-justified. It is worth remembering that 15 per cent MLR in October 1976 was followed by the remarkable transformation in Britain's financial position in 1977 and a return to single-figure inflation in 1978.
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