§ There is one proviso—and it is a crucial one. We must get inflation down, and this time we must keep it down. The overriding lesson of the past few years is that the battle against inflation is never won. It is fatally easy to miss the warning signs, and hard decisions have few friends.
§ The costs of even a temporary reverse are high. Squeezing out inflation means high interest rates, frustrated hopes, bankruptcies and lost jobs.
§ But the costs of living with inflation are even higher—as those who remember the 1970s know only too well. Inflation makes our industry uncompetitive; it destroys savings; it creates uncertainty and strife; and a high rate of inflation can quickly get out of control. High rates of inflation are never stable.
§ Frankly, after the experience of recent years, it surprises me how many people are urging me to let up on inflation. It may not seem much of a threat for the next six or 12 months, but I am concerned with the year after that and with the rest of the decade.
§ The Government's decision to join the exchange rate mechanism last October provides a more secure 167 framework for combating inflation in the future. That is its real significance. Linking sterling to other currencies with a proven track record of low inflation will be an added discipline on monetary policy.
§ We committed ourselves to that discipline after lengthy debate, and our decision was widely supported on both sides of the House, and in the country at large. The time has now come to apply ourselves wholeheartedly to the task of making our membership a success.
§ So far, it has been. Sterling has traded comfortably within its band during a difficult period. The sterling index is much where it was just before ERM entry, and our patient approach has meant that recent reductions in interest rates have been well received by the markets. They have recognised that they are consistent with our ERM obligations, as well as fully justified by the domestic economy.
§ Our entry into the ERM means that I have had to reassess the role of domestic indicators in guiding monetary policy. It should go without saying that interest rates will be set to honour our commitment to stay within the ERM band, but there is still a most important role for domestic monetary targets. All the major countries within the ERM take the same view.
§ Over the past year, M0—the narrow measure of money—has continued to provide timely evidence of monetary developments. Its annual rate of growth has been on a downward trend since last May. Since August, it has been within its target range of 1 to 5 per cent. For the year ahead, I propose to set a new, slightly lower target range of 0 to 4 per cent. That is consistent with my determination to exert further downward pressure on inflation. I shall also continue to watch closely other indicators of monetary conditions, especially M4—the measure of broad money—and asset prices.
§ There should be no sustained conflict between domestic monetary indicators and our ERM obligations. By far the best way of minimising the risk that conflicts will arise in the future is to build up credibility within the ERM. The policies that are necessary to defeat inflation and to sustain the exchange rate are the same.
§ For the time being, I have no plans to move to a narrow ERM band. That remains, of course, our longer-term intention, but the timing of the move must depend on the progress we make in reducing inflation.