§ 7.31 p.m.
§ Lord Blackwell
rose to ask Her Majesty's Government what policy criteria they would apply before directing the Bank of England to intervene in foreign exchange markets, and what are the criteria and the budget provision under which the Bank of England may use its discretionary power to intervene in foreign exchange markets.
The noble Lord said: My Lords, I thank the Minister for taking time to respond to the debate at a time when I know that he is busy on other matters going through the House. I thank other noble Lords for joining me in the debate.
The Government's foreign exchange policy is a critical area of economic management; one which does not always receive as much attention as other areas of economic policy which come more frequently before both Houses. However, a number of matters have led to the exchange rate policy being brought to the forefront of attention recently, which makes it appropriate to debate the policy in this way. The first is the pressure on the Government which has arisen from what is referred to as the "strong pound" or the "strength of the pound". I believe that it might more properly be referred to as the "weakness of the euro". The pressure from the strong pound has led to a number of questions in this House where noble Lords have called on the Government to intervene in the foreign exchange markets to try to adjust the pound's exchange rate.
The Bank of England's Monetary Policy Committee during February had a discussion on the exchange rate objectives and on the possibility of intervention. We are approaching a period when the Government, having declared their intention of moving Britain into the euro, may well be faced with pressures to try to intervene to manage the exchange rate in the period up to the pound's proposed entry.
My objective in raising the Question is to invite the Government to make an on the record statement of how they now view their powers to intervene in foreign exchange markets and, if possible, to receive some reassurance from the Minister of the circumstances in which they would not intervene; the limits to intervention.
717 The Government's powers to intervene in foreign exchange markets are extremely wide. They are set out in a letter from the Chancellor to the Governor of the Bank of England in May 1997. They fall into two parts. First, the Government themselves may intervene. The letter states,If the Government so instructs, the Bank, acting as its agent, will intervene in foreign exchange markets by buying or selling the Government's foreign exchange reserves. All such intervention will be automatically sterilised".Not only can the Government direct the Bank of England to intervene thus, but the Bank of England in the same letter is given discretion to intervene on its own account:The Bank will have its own separate pool of foreign exchange reserves which it may use at its discretion to intervene in support of its monetary policy objective".There is no definition in that letter or in other material that I have been able to find which clarifies the objectives by which the Government, or indeed, the Bank of England, may decide whether or not to intervene. For example, the Bank of England's website states of the foreign exchange reserves,These may be used, subject to policy objectives, to attempt to influence the exchange rate in case of need".The terms, "subject to policy objectives" and "in case of need" present a fairly broad canvas. I am not happy in a situation where the open powers to intervene in foreign exchange markets of both the Government and the Bank of England are set without clarity of the objectives and some limit to set the accountability with which they are used.
My own view, which I hope would find wide agreement in the House, is that history shows that intervention by governments to try to determine the exchange rate as a policy objective is not only doomed to failure, but is likely to be hugely damaging as well as expensive. That is true whether or not the intervention is sterilised. There are two reasons why I believe that intervention is not at all a viable policy and why the Government should, if possible, repudiate intervention as a policy which they might adopt. One reason is theoretical, the other practical.
The theoretical reason is simply that within any economic system there are only a limited number of variables which the Government can try to determine independently. If the Government have a policy of controlling interest rates and monetary policy domestically and a policy of controlling fiscal policy, I do not believe that they can independently attempt to control the exchange rate as well. The exchange rate becomes a dependent variable. Any attempt to try to control the exchange rate will simply result in pressures building up which will burst out in some other direction in due course, whether it be in inflation or unemployment.
The practical reason for disavowing intervention is the size of our foreign exchange reserves relative to the floods of money going through the foreign exchange markets every day. In practical terms it is simply not possible for the Government to spend enough to make a major adjustment to the exchange rate which is sustainable. Experience suggests that whenever 718 governments intervene, they tend to increase the amount of money normally flowing betting against them.
Despite those reasons for being cautious about intervention, governments have not been prevented from intervening on quite a large scale in recent history. Many noble Lords will remember the period during the 1980s, for example, when a policy of trying to set the exchange rate between the pound and the Deutschmark at around three Deutschmarks was followed. A number of people would suggest that that policy was partly responsible for some of the inflation which followed.
Similarly, in the period after the government joined the Exchange Rate Mechanism, the attempt to sustain the pound in the Exchange Rate Mechanism led to a period of intervention in the early 1990s which again was expensive and costly without any sustained benefit. In those and other situations, it is possible for governments to spend vast amounts of the nation's wealth for little effect. One of my concerns nowadays is that it may well be possible for governments to intervene in foreign exchange markets without it being readily apparent how much intervention is taking place in the accounts published simply by using forward contracts and intervention. Therefore, it is difficult to control the accountability of getting into situations where vast amounts of money are put at risk.
As we approach a period when the stated intention of the Government is to take the pound into the euro—a new fixed rate exchange regime by another name —I should like to ensure that the same temptations to intervene do not reappear. It would be attractive to think of the equivalent of a balanced budget amendment; for example, a Bill which stated that the Government and the Bank of England are simply not empowered to intervene beyond a certain limit over a period of time. However, we have no such law on the statute book at present. As I have said, the powers to intervene are open-ended and clear.
Given that the Government have those powers at present, I should like to ask the Minister to set out as clearly as he can the circumstances in which the Government believe it would be proper to consider intervention, and, directly or by inference, those in which he is prepared to declare that the Government would not consider intervention appropriate or proper.
I invite the Minister specifically to confirm that the Government would rule out the use of intervention to create what I would regard as a false convergence between the pound and the euro by trying to track the pound to the euro in any run-up to a policy decision on whether or not Britain will join the euro. There must be temptations for the Government, if pursuing a pro-euro policy in the years ahead, to see intervention as a tool. I should like the Government to declare, if possible, that they do not regard intervention to create false convergence as an appropriate use of those powers.
719 Finally, under the letter from the Chancellor which I read to your Lordships, the Bank of England has discretion to intervene on its own account. I should like more clarity about the circumstances in which the Bank of England might use those powers to intervene over and beyond day-to-day technical issues of managing foreign payments and our obligations to the IMF, and so forth. What amount of money will the Bank of England be able to spend on its own account to intervene in foreign exchange markets without reference and authority from the Government?
I believe those are important issues of policy but also of governance and accountability as to how the powers are used. It is fairly unusual for the Government to have such wide powers and for so little attention to be focused on the objectives around them and accountability for the use of such powers. I look forward to the Minister's reply.
§ 7.43 p.m.
§ Lord Desai
My Lords, we are grateful to the noble Lord, Lord Blackwell, for tabling this Unstarred Question. It is an important but difficult question. That is shown by the small number of participants, but perhaps I may say that only the select can talk on such subjects.
I am relieved by the way in which the noble Lord put his argument. I was somewhat worried that we might have a lobby for the manufacturing industry trying to get the pound down. I always dread that kind of debate. However, all I can do is to agree with the noble Lord, in many ways, and expand on my perspective on the problem.
I agreed with the noble Lord when he said that of the three main objectives of government policy—that is, inflation, employment and exchange rate stability—we can at most control two. That is what I call a "missing equation" problem. If we are in a fixed exchange rate regime, as the euroland is, inflation can be controlled but employment cannot be. Employment and the failure to control it is the variable which is taking all the strain of euroland.
There have been many experiments in the UK on this question. Our obsession with the foreign exchange position blighted economic policy through the sixties, seventies and eighties. I am glad that, following our exit from the exchange rate mechanism, we have decided that what really matters is to establish a credible regime for fiscal and monetary policy and then let the exchange rate do what it wants to do. Of the three objectives of government policy, the exchange rate is the least controllable by a national government, especially in today's markets, where, as the noble Lord stated, private investors can throw a wall of money at the Government if they try to lean against the wind. It is no use throwing good money after bad and putting your nose out of joint.
It is particularly interesting to note that my right honourable friend the Chancellor strengthened the credibility of monetary policy by his decision to give independence to the Bank of England as regards the 720 rate of interest. He has also established a credible fiscal regime by his code of fiscal stability. Those two provisions having been put in place, it is but logical that the exchange rate should be allowed to find its own level. The noble Earl, Lord Northesk, may not say this but perhaps I may remind him that the person who forecast that the pound would be the strongest currency in Europe was none other than John Major, a couple of years after our exit from the ERM. At that time, everybody fell about laughing. Either he was lucky in his forecast or he was clever. However, it is true that our exit from the ERM taught us many lessons. One such lesson was that, if the UK is to have a credible economic policy, it cannot rely on external constraints and straitjackets. It has to internalise fiscal and monetary discipline, learn the lessons and set up institutions which are credible in the eyes of the world.
I do not mind saying that I fully supported our entry into the exchange rate mechanism. At that time I did so because I could not believe that any Chancellor of the Exchequer could be trusted to run a stable fiscal regime. At that stage I became an Ayatollah of balanced budgets. I decided that because we could not trust a UK chancellor, we had to put him in a straitjacket. As it turned out, for various reasons the ERM did not succeed. However, for the record, I have to say that it succeeded in lowering inflationary expectations in this country in the most drastic way possible—something which all through the 1980s we could not do. We had high unemployment yet still high wage settlements. We persisted with the high rate of inflation. The ERM experience, painful though it was, and perhaps because it was painful, knocked inflationary expectations on the head and we were then able to recover.
The secret of a good policy outcome today is partly that globalisation has reduced the rate of growth of manufacturing prices worldwide. We are therefore not importing inflation. Secondly, a stable fiscal and monetary regime is driving inflation down and inflationary expectations are in step with inflationary experience.
So far, so good. That immediately raises a question posed by the noble Lord: are there any conditions under which the Bank of England should intervene? The answer is "no". Should we nudge our currency towards Europe? I do not know what my noble friend will say from the Dispatch Box but I would say "no". These matters are no longer invisible; they are transparent and the markets will find out. Then they will punish one for messing around with the foreign exchange rate.
I also believe that the policy and financial conditions that have been laid down say, more or less, that it is the convergence of the cycle that matters a great deal. I do not think there is a desirable exchange rate which we ought to aim for on entry into the euro. This may sound somewhat heartless, but I have been saying that for the past year in meetings of the Peston committee. The high level of sterling has nothing to do with the balance of trade and so forth. Rather, it is the UK's good position as an attractor of foreign direct 721 investment that has made the pound so strong. Short-term interest rates are high and there is some small influence from those rates. However, what really makes sterling strong is that the UK has become a very good attractor of foreign direct investment.
In the globalised context of today's markets, it is capital movements which are the major determinant of exchange rates, rather than trade deficits. Nevertheless, an obsession with trade deficits persists in many quarters, but I believe that that thinking is completely out of date. We now have an exchange rate that is effectively produced by movements of capital and, in that context, it makes no sense for people to say, "The Government should do something to bring down the pound". That is a silly way to approach the issue, for two reasons.
First, if we consider the pound/dollar exchange rate, it is clear that the pound is not particularly high. The pound has stayed at more or less 1.60 dollars for a long time. Indeed, it is a little weaker at the moment, down to 1.57 dollars. Secondly, it is only the pound/euro exchange rate where the pound looks so expensive. That has happened because the euro started at a ridiculously high level and was not neutralised by the European Central Bank, which was formed six months before the euro was launched. That mistake meant that the euro began too high and then declined to some 18 to 20 per cent below its starting level. However, that is the ECB's mess.
United Kingdom policy should declare itself free from the old habits of trying to steer the pound here, there or anywhere else. I believe that the Government have given a clear signal, in the absence of any reference to exchange rates in the Budget speech, that the UK Government are not going to intervene in those rates. That, I believe, is the correct policy.
§ 7.52 p.m.
§ Lord Haskel
My Lords, I agree with both my noble friend Lord Desai and the noble Lord, Lord Blackwell. This is indeed a very important subject, and I thank the noble Lord, Lord Blackwell, for tabling this Question, because it has given me an opportunity to say that I hope that the Government will not be persuaded by noble Lords to intervene in the foreign exchange markets. If they do, I agree with what the noble Lord, Lord Blackwell, has said; namely, that the law of unexpected results will operate with a vengeance. That has been our experience in the past. I believe that is because we do not really understand the reasons why the foreign exchange markets fix a rate. As my noble friend Lord Desai has reminded us, the ERM experience should provide enough evidence of that.
Because we hardly understand the causes of the so-called strong pound, who knows what the effect of intervention will be? Perhaps the pound is not all that strong. Some say that it is the euro that is weak and that the rate of sterling against the dollar and the yen is competitive. But what is competitive? My noble friend Lord Currie, in his book on European monetary union, reminds us that in 1966 there were 11 deutschmarks to the pound, but by 1996 the rate 722 was 2.3 deutschmarks to the pound. That represents an average depreciation of 5 per cent a year. Did this mean that our goods were 5 per cent more competitive each year? Obviously they were not.
So what is it that fixes the exchange rate of sterling? Is it interest rates? Certainly interest rates are an important factor, but, as my noble friend Lord Desai has reminded us, it is not a straightforward issue. Rates are much the same here as they are in the United States, but they are much higher than in Europe or Japan. For that reason, the relationship is uncertain.
However, interest rates are now the responsibility of the Monetary Policy Committee, which is an independent body. The committee's obligation is to keep inflation down to the Government's target of 2.5 per cent. If the exchange rate were to fall and inflation rise, the committee would be obliged to increase interest rates, which would probably affect the exchange rate and bring it back to where we started.
Perhaps the foreign exchange markets regard our management of the economy as sound enough to warrant a healthy exchange rate. Is it that the foreign exchange markets believe that the old days of boom and bust in Britain are over and that a more stable economy merits a higher exchange rate? I agree with my noble friend Lord Desai: perhaps we have convinced the foreign exchange market that devaluation is no longer a fiscal tool available to the Government. If this analysis is correct, it is not economics that we need to manipulate the exchange rate, it is market psychology. The exchange rate is probably a combination of all of these factors— political, economic, psychological—and they are constantly changing. That is why we really do not understand what is going on and what are the causes.
Even if we did understand, how would we intervene? The noble Lord, Lord Blackwell, made the point that sterling is a popular currency for short-term speculation. He reminded us that the world's annual trade in sterling is turned over every few days on the foreign exchange markets. We would need very deep pockets to make an impact on that.
Some say the commitment to join the euro at a given exchange rate is the answer. However, I am not sure about this. It seems to me that the reasons for joining the euro are surely much wider than merely lowering the current rate of exchange. Certainly the deficit on goods traded with the European Union rose from £4 billion in 1997 to £6.2 billion in 1999, but that is nothing compared with our deficit with the rest of the world. That deficit had gone up from £7.9 billion in 1997 to £20.4 billion in 1999.
I say no. The decision to join the euro has to be made in the interests of the economy as a whole. That interest is to benefit from the stability of being part of a big currency block. In short, I think it is the Government's task to inform the market, but not to control it.
723 Now, I am afraid that I shall irritate my noble friend Lord Desai because I should like to say a few words about manufacturing. That is because I happen to think that talk of managing the exchange rate is a cynical diversion from the real task; namely, the task of modernising industry and encouraging it to be more competitive. What the Government can do is to encourage modernisation and competitiveness. They can set a good example. They can apply the old-fashioned stick and carrot; they can use exhortation and encouragement to make the economy more competitive.
I think that the Government are having a good shot at this. They are setting an example by encouraging the public sector to be more efficient and effective. They are improving our infrastructure. They are using the Internet in their relationship with industry. They have passed the Competition Bill and regulations directed towards competition. There are many carrots in the numerous schemes to assist and encourage the introduction of new technology, better management, innovation and training. In the medium and long term, that is the way to build a healthy economy: get productivity up rather than get the exchange rate down. That is because devaluation hardly works, even in the short term.
During the 1970s and 1980s—the heyday of devaluation—I worked in the textile industry. I can clearly remember that within hours of devaluation being announced, the telex machines would start chattering with messages from our overseas customers demanding price reductions equivalent to the devaluation, even on orders where the price had already been agreed. I usually met regular customers part way, otherwise they would just take discounts off repeat orders or the next season's order. The benefits were very short term and the whole exercise did nothing to increase our competitiveness. Indeed, it focused attention on price, rather than on price together with quality, design, delivery, service and innovation—which is how businesses thrive. Our Italian competitors actually learnt that lesson very well. As a result, Italy still remains the second largest exporter of fabric in the world after China.
Of course, the exchange rate is part of the competitiveness equation. But achieving competitiveness through managing the exchange rate is a diversion from the real task of achieving competitiveness through the management of business and economy. I urge the Government not to do it.
§ 8 p.m.
§ Lord Newby
My Lords, I, too, am grateful to the noble Lord, Lord Blackwell, for initiating this debate. I am slightly depressed in one sense in that I have to agree with a large measure of his broad conclusion. I was hoping that we would have some root-and-branch supporters of old-style intervention in the debate. Unless the noble Earl, Lord Northesk, is about to spring a surprise, I suspect that we shall not.
724 I agree with the theoretical proposition that it is impossible to control inflation, employment and the exchange rate all at the same time. It is rather like a partially filled balloon; when we try to push one part down, the balloon inflates in another. However, it is possible—here I disagree with the noble Lord, Lord Desai—to increase the levels of employment with a set exchange rate and a set inflation target by supply-side measures. The Lisbon Summit looked at ways in which, other things being equal, we could still improve levels of employment simply by improving skills levels and the workings of the labour market.
I disagree slightly with the noble Lord, Lord Desai, also when he says that there is one fundamental reason why the exchange rate is at a specific level. He mentioned the attractiveness of the UK as a haven for inward investment. But one of the things that struck me in one of our first meetings of the Monetary Policy Select Committee was the Governor of the Bank of England admitting that he could not explain why sterling was so high at that point. I agree with the noble Lord, Lord Haskel, that there is no consensus as to why, at any one point, an exchange rate is at a specific level. I have a lot of sympathy with the Keynesian view that animal spirits have a lot to do with the way that markets work and that they are, by definition, difficult to pin down.
But the one thing with which I suspect most people in this country, if not everybody in this House, will agree is that the effect of the current exchange rate is that the manufacturing sector is really hurting. Although Rover has had the headlines recently—one can argue about the extent to which Rover was affected by the exchange rate—all the evidence I have heard from my colleagues in another place in relation to manufacturing plant in their constituencies, whether in the far south-west, the Midlands or the north, suggests that the manufacturing sector is suffering greatly from the current rate of exchange. We saw today another big closure announced in Liverpool in the manufacture of boots and I suggest that the exchange rate was at work there.
Assuming that we agree that old-style intervention does not work, and that for the manufacturing sector an exchange rate somewhat lower than the current one is desirable, what can we do about it? The Government's policy, both to deal with the short-term manufacturing problem and as we look towards joining the euro, is what might be called reverse Micawberism; that is, not hoping that something turns up, but hoping that something turns down, and that the exchange rate will turn down of its own volition.
There are some reasons for optimism on that score. The growth rate of the American economy cannot carry on at its current level year after year. At some stage there will be a reversal and at that point the European economy will look stronger by comparison, though I suspect that sterling will suffer in the crossfire. However, economists have been predicting that kind of shock for some considerable time, some of them in apocalyptic terms. It has not happened yet and 725 perhaps never will. Therefore, like Mr Micawber, I am not sure that the Government are wise to rely on it happening.
When looking to see what might be done, it may be remembered teat my noble friend Lord Taverne explained in this House on a number of occasions that there may be limited scope for sterilised interventions. I recommend to all noble Lords the research paper by Mr Bofinger, Options for the Exchange Rate Management of the ECB, which sets all that out in considerable detail. However, I have doubts as to how successful those interventions could be in the longer-term.
One thing that would have an immediate effect on the exchange rate, in the direction in which both the Government and manufacturing industry wish it to go, is an announcement that the Government intend to hold a referendum on joining the euro within a certain timescale in the next Parliament. Why should that have any effect on today's exchange rate? Because it gives certainty to the long-term position in respect of the movement of interest rates in this country. I am informed by colleagues in the City that the effect of such an announcement would mean that pension funds would greatly increase their holdings of long-dated French, German and other euro-zone bonds. That in turn would have the effect in the marketplace of bringing down the rate of sterling somewhat.
The problem we are faced with at the moment is that the lack of such a clear statement means that the Government are not credible when they talk in the changeover plan of working towards euro-zone membership. The truth is that in the City people do not believe the Government when they say that they have a bias towards joining early in the next Parliament. They believe that they will simply wait until after the next election, look at the polls, and take a view then; that there is no philosophical or practical commitment to that move. Therefore we are stuck with the high pound.
The answer to the question therefore of whether the Bank can intervene is "Yes, it can". But should it intervene? It almost certainly should not. I shall be interested in the Minister's suggestion of the circumstances in which they might consider intervening. I suspect the Minister will say that there are no intentions to intervene. What I should really like to hear is that the Government intend to set a timetable for a referendum to join the euro. But I hardly expect him to do that tonight.
§ 8.8 p.m.
§ The Earl of Northesk
My Lords, I, too, am grateful to my noble friend Lord Blackwell for giving us the opportunity to debate this important matter, not least because we strolled through some of the ground at Question Time today.
It is one of the Chancellor's proudest claims that the Government's economic policies have ended the cycle of "boom and bust". A cursory glance at the overall figures for the economy could persuade the casual observer that the claim was justified. With due 726 apologies to the noble Lord, Lord Desai, although I hope he will draw some comfort from my conclusions, there is another side to that coin. A number of sectoral interests—notably, manufacturing and agriculture—are in dire straits, substantially (but not exclusively) because of the strength of sterling.
As Sir Brian Moffat, chairman of Corus observed,Manufacturing industry in the UK is fighting for its very existence and will continue to do so. It is extremely efficient but the impact of the continued strengthening of the pound on its cost base is remorselessly undercutting its competitiveness".Equally, while conceding that it is not as simple as the phrase implies, the "north/south divide" continues to be a running sore. As Nissan has observed:Should the present circumstances continue unchecked, the UK's manufacturing exporters, their export markets and our domestic markets, are at grave risk".The company then added that its position in Sunderland "is particularly vulnerable".
Even Eddie George has conceded that,the worry is that it"—that is, the strong pound—is producing real, sustained damage in some sectors of the economy".In effect, the claim by the Chancellor of the Exchequer that "boom and bust" has been excised is credible only when it is applied to the economy as a whole. By definition, the economy is the sum total of its parts. To this extent, it is currently the product of the countervailing forces of a booming "new economy" set against a relative bust of the "old economy". This widening divergence—in effect, a form of internal boom and bust—is attributable in very great measure to the Government's failure to address the issue of the strength of the pound.
What all of this should tell us is that, in order to be prudent, government economic policy should be geared towards rather more than that which is expressed in the Minister's statement that:The best contribution that the Government can make to exchange rate stability, consistent with their objective of a stable and competitive pound over the medium term, is to maintain sound public finances and low inflation".—[Official Report, 1/3/00; col. 554.]The Minister has used this Treasury mantra on more than one occasion. No doubt he will use it again tonight, as he did earlier today. He will also, no doubt, repeat yet another of the Treasury's mantras; namely,we do not underestimate the difficulties, particularly for manufacturing industry, of a strong pound".—[Official Report, 1/3/00; col. 555.]But to what extent is it a consequence of the Government's economic policies that the pound's exchange rate with the euro is continuing to be, in the words of the Governor of the Bank of England, "unsustainable"? Moreover, in so far as the Chancellor of the Exchequer may have measures of control at his disposal, can the Government legitimately claim that they are managing the situation prudently?
The thrust of my noble friend's Question is to acknowledge that these difficulties exist and to inquire whether the Government believe that exchange rate 727 intervention would represent an appropriate mechanism with which to tackle them. On the basis of statements from the Government to date—perhaps the Minister could confirm this again tonight—the straightforward answer would be a categoric and unequivocal "No". In January, the Minister said:I thought that I had already sufficiently clearly rejected the option of using a policy of intervention, sterilised or unsterilised, in the exchange rate".—[Official Report, 27/1/00; col. 1665.]Then, only last week, he added that,we do not fully understand what makes exchange rates tick. Attempts to deal with them by direct intervention are likely to be doomed to failure".—[0fficial Report, 21/3/00; col. 138.]Increasingly, and, no doubt, arising in part from Eddie George's insistence that the MPC's ability to influence the pound,is not zero but is not very great either",the argument is being advanced that the way past this conundrum is to extend the remit of the MPC. But it has to be said that the relationship between interest and exchange rates, as the Minister conceded, is far from being an exact science. More than this, in evidence to the Treasury Select Committee in the previous Session, the Governor of the Bank of England was adamant that,we do not believe that we can target the exchange rate consistently with targeting inflation".As the Chancellor of the Exchequer said in the same forum,anybody who thinks that either dropping the inflation target to replace it by an exchange target or running inflation and exchange rate targets at the same time is the right way to achieve domestic stability or convergence is failing to learn the lessons of the 1980s".All good and well.
Sentiment is in favour of a policy of benign neglect of exchange rates. For our part, we on these Benches support that and acknowledge the part that a strong pound plays in sustaining the overall strength of the economy. As far as concerns any central intervention, all recent evidence, not least the break-up of the ERM in 1993 or the Bank of Japan's attempts to weaken the yen last year, endorse that view.
However, this is not to say that the Government's hands are entirely hog-tied. There are a number of measures in the fiscal jam jar, not least appropriate co-ordination of fiscal and monetary policy, which, when deployed with foresight, can have the effect of producing a better balance between the "new" and "old" economies and, indeed, of rationalising the north/south divide. This really would be "prudence with a purpose". As Geoffrey Dicks at Greenwich NatWest observed yesterday in his evidence on last week's Budget:Fiscal policy has started working against monetary policy rather than with it".There is a wider context to this debate to which my noble friend Lord Blackwell alluded. There are those who suspect that the Government might be tempted, at some unseen point on the horizon, to use intervention as a mechanism to deliver artificial currency convergence and thereby shoe-horn the UK 728 into the euro. In this context, Eddie George's comments on the matter leave no room for doubt. He said:I have made it crystal clear that if the Government wished us to lower the exchange rate for entry into Euro purposes, it would have to change our marching orders. We would not accept a situation where we were mandated by law to move in one direction and asked to move in another".I trust that the Minister will confirm that this is wholly consistent with the Government's position. Having said that, I cannot resist making the point that, as observed by my noble friend Lady Hogg in the Financial Mail recently:Somewhat contradictorily, Ministers extol the virtues of a single currency while washing their hands of the pound's rise".Until recently, sterling's strength was having a beneficial effect on Britain's economy in terms of containing inflation and, indeed, in terms of restructuring. However, current evidence—such as the fact that, for the first time in 20 years, hourly labour costs are now higher in Britain than in France—suggests that that period has now passed. To my mind, Anatole Kaletsky summarised the position well by saying that,in the absence of further remarkable productivity improvements, the strengthening of the pound may now be reaching the point at which it could do the British economy serious—and lasting—economic damage and trigger a balance of payments crisis".In our view, noble Lords on all sides of the House quite rightly agree that intervention does not provide the solution to such problems. But the simple question remains: how, therefore, do the Government intend to address these problems?
§ 8.17 p.m.
§ Lord McIntosh of Haringey
My Lords, I propose to pay the noble Lord, Lord Blackwell, the compliment of taking his questions literally. I do not propose to deliver a sermon on government economic policy and I do not propose to repeat the mantras; indeed, I do not need to do so, because the noble Earl, Lord Northesk, has done that for me. I have been saved from delivering a considerable part of my speech.
In his Question, the noble Lord, Lord Blackwell, asks, first,what policy criteria [the Government] would apply before directing the Bank of England to intervene in foreign exchange markets;secondly,what are the criteria";and thirdly, what is the,budget provision under which the Bank of England may use its discretionary power to intervene in foreign exchange markets"?The noble Lord prefaced his speech on those questions by quoting the directions to the Bank of England, which, as he rightly said, are couched in very wide terms. That is simply because the policies may change over time; indeed, no policies are expected to endure for ever and it may be necessary for changes to take place in the actual direction of policy which do not necessitate a dramatic change in directions to the Bank of England. The noble Lord is right to say that we must be a little more precise now about our views. 729 I propose to answer his questions by setting them in the context of the existing situation, and not to make forecasts for the long distant future.
Both the Bank of England and the Government hold reserves of foreign exchange. The Government reserves are held in the Exchange Equalisation Account (EEA), which is operated by the Bank as the Treasury's agent. In addition, the Bank manages its own pool of foreign exchange reserves which the MPC may use to intervene in support of its monetary policy objectives. Details of the EEA and Bank reserves are disclosed in the Treasury's monthly press notices entitled, UK Official Holdings of Foreign Currency and Gold, and in quarterly reports published jointly by the Bank and the Treasury. At the end of February UK government reserves totalled about £20,000 million while the Bank's reserves totalled about £5,000 million.
Therefore, the answer to the first question is that the major objective of the Government's macroeconomic policy framework is to deliver greater economic stability for the United Kingdom. It is clear that the Government would seek to intervene in foreign exchange markets only if they believed that such a move was consistent with their objective of delivering greater economic stability.
The noble Lord, Lord Blackwell, and others, including the noble Lord, Lord Desai, asked me about the issue of what the noble Lord, Lord Blackwell, called false convergence and what the noble Lord, Lord Desai, called a nudge towards the euro and asked whether there would be an additional condition under which we might be tempted to intervene in foreign exchange markets—in other words, if we thought that it would be advantageous to us in the move towards the euro. I think that the noble Lord, Lord Newby, referred to the same issue.
We would certainly not attempt to use foreign exchange intervention to achieve false convergence with the euro. The Government's policy on convergence and the conditions under which we would advocate entry into the euro are clear and have been repeated on many occasions. I certainly have no intention of either rewording or seeking to modify the statement of the Chancellor in October 1997 or the statement of the Prime Minister in February 1999. Therefore I think that we can put that issue firmly on one side.
I move on to the second and third questions of the noble Lord, Lord Blackwell. In practice, the sheer size of funds involved in currency markets severely limits the effectiveness of intervention. The Government's reserves amount to only a small fraction of the total size of the foreign exchange markets. Attempts to intervene are unlikely to have the desired effect in most cases—as I think all noble Lords have agreed—and could create uncertainty and instability in the market. In addition, they could raise doubts as to whether the Government were adopting a target for the exchange rate in addition to their inflation target, which is clearly not the case.
730 We should also note that any intervention made by the Government would be automatically sterilised; that is, offsetting changes would be made to the money supply. This is because unsterilised intervention is effectively equivalent to changing interest rates, and so it would act against the Monetary Policy Committee's responsibility to set interest rates to meet the Government's inflation target, damaging the credibility of the UK monetary policy framework. However, both theory and empirical evidence indicate that intervention is even less likely to be effective when it is sterilised, thereby further limiting the scope for government intervention. I think that reflects the theoretical and practical reasons which the noble Lord, Lord Blackwell, set out in his speech.
As I said earlier, the Monetary Policy Committee may also use the Bank's reserves in support of its monetary policy objectives. That is the answer to the third question of the noble Lord, Lord Blackwell. This means that the Monetary Policy Committee would intervene only if it thought such a move would help it to maintain price stability and support the Government's growth and employment objectives. That is the answer to the second question of the noble Lord, Lord Blackwell. The MPC has considered the question of intervention on a number of occasions over the past three years and the minutes of its meetings provide a thorough account of the reasoning behind the decisions not to proceed with intervention. In particular, members of the MPC have also made the point that the size of reserves that the Bank commands is relatively small compared with the size of the market, limiting the effectiveness of intervention.
The issue of intervention was previously considered in detail at the February meeting of the MPC. The MPC again decided against intervention with some members arguing that,it was doubtful whether intervention would be effective as there was little evidence that the market consensus which sustained sterling at its current level was fragile".It was also noted that a failed attempt to intervene would damage the MPC's credibility and that,to the extent that sterling's strength mainly reflected euro weakness, the MPC could do very little about itWe went over that point at Question Time today.
Appearing before the Treasury Committee on 29th February, the Governor argued that intervention,would be ineffective and aggravate upward pressure on the pound".It is clear that the scope for intervention is limited. The Government believe that artificial means of bringing down the value of sterling should be treated with considerable caution. I say "with considerable caution" as perhaps the understatement of the year! I am sorry to make my next point as the noble Earl, Lord Northesk, has already predicted that I would make it. I am grateful to him for that. Maintaining greater economic stability, based on low inflation aid sound public finances, is the best way to deliver 731 exchange rate stability consistent with the Government's objective of a stable and competitive pound over the medium term.
§ [The Sitting was suspended from 8.25 to 8.32 p.m.]