HC Deb 20 March 1990 vol 169 cc1014-6

I want to deal with monetary policy and interest rates first, for two reasons: because they are of great concern in the House and in the country, and because, as always, they provide the key to progress on inflation. I repeat, my first priority is to prevent inflation from entrenching itself, for inflation is immensely damaging socially as well as economically. It damages business by undermining planning and investment and it foments industrial strife—and, socially, it penalises the weakest most.

I know that high interest rates are unpopular. They are generally most unpopular as they become most effective. They discourage spending and borrowing. They act directly on the things we have to control if we are to get inflation down. Interest rates are also the most flexible way of responding to what can be a rapidly changing situation. They can be raised quickly when necessary, and they can be reduced just as quickly when it is safe to do so.

In recent months, I have looked carefully to see whether there is any effective alternative to interest rates. I have done so because I am very conscious of the burden they place on business and on individuals purchasing their own homes.

I know that many people favour direct controls on lending, hire purchase and consumer credit. I understand that. In particular, I understand the distaste many people feel for the widespread marketing of credit that is so evident today and that is characterised by indiscriminate mail shots encouraging people to borrow. I believe that the financial institutions would be wise to reconsider their policy, and I hope that the subject will be covered in the code of practice the banks and building societies are currently preparing following the Jack report.

However, having looked at the matter, I have concluded that it is extremely unlikely that credit controls would work in the modern world in anything other than the very short term. They were becoming less and less effective even before exchange controls were abolished over 10 years ago. Their main impact now would be to replace domestic borrowing with overseas borrowing. These days it would, for example, be a simple matter for any high street bank to arrange its lending through an overseas branch.

That, of course, applies to other countries too, and it is for that reason that Governments of all persuasions throughout the western world are abolishing credit controls and are relying on interest rates to control money, and thus inflation. The same is true of those countries in eastern Europe which are seeking to adapt to the market system.

In recent years, financial markets have become more open to competition, and their behaviour has changed enormously. As a result, monetary conditions have become more difficult to judge. This is one of the problems of financial deregulation, but one that must be set against the benefits that it has brought.

Therefore although monetary policy remains the key to controlling inflation, it is not realistic to suppose that we can take decisions solely by reference to the way any one particular measure of money is growing. In a more sophisticated world, we must apply judgment and take into account the other evidence about monetary conditions that may be available.

In recent weeks, I have looked afresh at the role of monetary targets. Having done so, I am clear that it is sensible to retain a target for narrow money, and that this is best measured by the familiar aggregate M0. Since this is essentially notes and coin, it clearly is not a comprehensive measure of money in all its uses, but it does have value as an indicator of transactions and has been a reliable guide for many years. For next year, I have set the target range at 1 to 5 per cent. Although the growth of M0 has fallen from its earlier peaks, it is likely to start the year above the range, and it may be some months before it falls within it.

In this re-examination of policy, I have also looked closely at the case for reintroducing a target for broad money. I can understand why some favour this. At times, broad money has given a useful indication of the build up of inflationary pressure. The difficulty is that its message has always varied in quality: its growth can represent money that is about to be spent, or money that is very definitely being saved: savings which I wish to encourage, as will become apparent later this afternoon. Although we will monitor M4 carefully, and give it weight in our decisions, I do not intend to set a target for the year ahead.

I have also reviewed whether there should be any changes in the Government's funding policy. The objectives must be to manage public debt in a way that supports monetary policy in bearing down on inflation, without distorting financial markets. I have concluded that, in general, policy should continue to be guided by the funding rule followed in recent years, with the public sector avoiding sustained under or overfunding.

However, I am also clear that, in practice, the rule cannot and should not be operated rigidly. In particular, in recent years there has been an increase in the size of the Treasury bill issue, largely as a result of a change in the financial position of local authorities. I therefore announced to the House on 15 February a range of measures intended to limit local authority borrowing from the Public Works Loan Board. This change should, in due course, allow a reduction in the Treasury bill issue, but in the meantime, the Government will adjust their funding operations if necessary, increasing gilt sales or reducing gilt purchases, to take account of the overall situation in the money market.

Progress on reducing inflation is also a vital precondition of our commitment to take sterling into the exchange rate mechanism of the European monetary system. Our commitment to do so was set out at Madrid. It remains firm, and the conditions for entry remain unchanged. When we join the exchange rate mechanism, it will provide a new framework for interest rate decisions, but even then, no one should suppose it will bring a dispensation from the need for strong domestic monetary control—indeed, quite the reverse. Commitment to the one will reinforce the commitment to the other.

To sum up, interest rate decisions will continue to be made on the basis of the growth of monetary aggregates, and a range of other evidence, most notably the exchange rate. This matters because it provides important information about domestic monetary conditions—quite apart from having an effect on prices. Therefore, I favour a strong exchange rate. However there is, as I have made clear, no single lodestar to guide us in monetary policy. Life would be simpler if there were, but it simply does not exist, so judgment is unavoidable.

My judgment is that interest rates will stay high for some time to come. The moment I judge I can safely lower them, I shall, but to reduce them prematurely only to increase them again would be extremely damaging. When I bring them down, it will be because I believe that they are likely to stay down.

In chapter 2 of this year's Red Book, I have provided a much longer and more comprehensive account than usual of how monetary policy, including funding policy, is to be operated over the years ahead. I hope that this will be helpful to the House and, in particular, to members of the Select Committee on the Treasury and Civil Service when they come to examine the Budget documents in detail.

Forward to