UK Monetary Policies: Interest Dilemma

Date : 14 April 2002

To : The Editor, The Business

From : Nagindas Khajuria

Subject : UK Monetary Policies

UK Monetary Policies

Interest dilemma

Sir - I found your article (31 March/2 April) very interesting which examined the monetary policy committee's dilemma when consulter demand and private borrowing is rising fast, making them inclined to raise interest rates to deflate the economy and also presented the counter arguments by Shushill Wadhwani that the increase may inflate rather than deflate the economy.

The 2.5% a year inflation target was set in 1997 when interest rates were generally higher than now. I believe the MPC should now urgently seek new guidelines from the chancellor in his next budget for several reasons.

First, UK GDP as part of the world GDP is only about 5%, Germany's being 10%, Japan's 20% and the US's 30%. Historically, all the latter countries (except the UK) had lower interest rates. To compete with them, we also need to keep interest rates low.

Second, there are signs of unease in the public sector and wage demands are now surfacing more regularly. Increasing interest rates will only fuel cost-push rather than demand-pull inflation.

Third, your article suggests that mortgage borrowing is rising at the rate of 10% a year. But house prices are rising at a similar rate. The increased borrowing may be partly for excesses, but partly for durable goods and construction and improvement of properties. So it is good for the economy.

Fourth, UK competitiveness in trade in manufacturing has risen very poorly compared with the rest of the world. If we take relative export prices as 100 in 1990, the 1998 prices were 117.2. By contrast, the relative import prices in 1998 were 108.6.

Fifth, if sterling has risen against the euro since the euro's inception, it will rise more by an increase in interest rates and our competitiveness will be even worse.

One idea could be to "aim" for 0% inflation in five years time by reducing the inflation target of 2.5% by 0.5% each year so that we reach the goal by year five. Long-term measures are far better than short-term measures. Whether we join the euro or not, our import-export trade with the European Union is 57% of our total international trade. It makes sense to aim to counteract the 25% appreciation of sterling since 1996 by a 25% depreciation of sterling against the euro by 2007. For all these wider reasons, I believe interest rates should remain very low constantly for at least the next five years.