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Mr. Gibb: I support amendment No. 1. Clauses 11 and 12 are key to the monetary objectives of the Bank of England, once it achieves independence. Clause 11 states:


Subsection (b) continues:


    "subject to that, to support the economic policy of Her Majesty's Government".

It is interesting how the phrase "subject to" has crept into the drafting of the Bill, whereas in letters from the Chancellor to the Governor of the Bank of England and to the Chairman of the Treasury Select Committee, the phrase has always been "without prejudice to". I do not want to go into semantics to see how distinct is the difference between those two phrases, but "subject to" subjugates the pursuit of the Government's other economic objectives to the overriding objective of maintaining price stability.

Clause 12(1)(a) enables the Treasury to write to the Bank of England to set out what the Government understand by the phrase "price stability". Subsection (1)(b) enables the Treasury to write to the Bank of England to set out its economic policy to enable the Bank of England to conduct its monetary policy in accordance with Government wishes.

7.30 pm

There is, however, no mention in clause 12 of what the Bank of England should do when there is a conflict between the Government's economic objectives and the Bank of England's overriding objective of maintaining price stability. That is why amendment No. 1 seeks to add a new paragraph (c), which states:


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    That enables the Government to write to the Bank of England to specify how that should be done.

There are three principal areas where there could be an important conflict between monetary policy being conducted by the Bank of England and other economic measures being taken by the Treasury and the Government. The first relates to the exchange rate. The Bill gives the Treasury responsibility for conducting exchange rate policy. At the moment, we have a high level of sterling and the Government are also maintaining a tight monetary policy because they fear the re-emergence of inflationary pressures in the economy. Therefore, even today we have the possibility of such a conflict.

The position could arise where the Government were concerned about the high level of sterling. Farmers throughout Britain have lobbied the House this week and they share that concern. As a consequence, the Treasury could conduct a foreign exchange policy of trying to bring down the level of sterling. It would do that by selling sterling into the market. The result of that would be an increase in the money supply in Britain.

Meanwhile, the Bank of England would try to maintain price stability and would monitor the money supply. When it saw the increase in the money supply, the Monetary Policy Committee would want to trigger higher interest rates in order to counter that. It would not know that that increase in the money supply was the result of a deliberate action taken by the Treasury to bring sterling down by selling sterling into the market. It would look at the data and believe the increase to be a normal activity in the economy, along with the shocks and various other influences that affect it. The amendment enables the Treasury to tell the Bank of England what its exchange rate policy is because it sets out what it should do in the case of a conflict.

In Committee, the Paymaster General and other Ministers were asked what the Government's exchange policy was, to which there was no response. Time after time, we asked the Paymaster General how such a conflict would be resolved. It is a genuine conflict. No Minister seems to be able to say how such a conflict should be tackled. At the moment, the Treasury is responsible for interest rate and exchange rate policy, but when the two are split and the knowledge of the two different entities is divorced, there is no way in which one hand will know what the other is doing and there will be conflict. We could end up with the dog chasing the tail. The Government could sell sterling to the market, thus increasing the money supply, leading to their raising interest rates further and pushing sterling up. The Treasury would sell more sterling into the market to bring the level of sterling down, and the vicious circle would continue. It is a recipe for chaos.

The second area where potential conflict exists is in the management of Government debt, which is to be handed over to a quango of the Treasury. Again, there are different ways in which to manage debt. There is, for example, the fully funded method of managing debt. If the Treasury, which is handling debt management, decides to maintain a fully funded policy, and if debt is sold to the non-banking sector when there is a public sector borrowing requirement, the money supply will decrease.

Meanwhile, the Bank of England could well be trying to ease monetary policy because it was concerned about deflationary pressures in the economy. Again, one hand

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would not know what the other was doing. The activities of the debt management side of the Treasury could do precisely the opposite of what the Bank of England was doing.

The final area of conflict is that between fiscal and monetary policies. Again, fiscal policy makers are divorced from those conducting monetary policy. The Treasury could be busy relaxing fiscal policy for various social reasons--to improve incentives in the economy or to increase spending in certain areas. Meanwhile, the Bank of England, fearful of inflationary pressures in the economy, could be raising interest rates, pursuing a tight monetary policy.

As there is no symbiotic relationship between the two organisations, one could be pursuing a policy directly opposite to that of the other. There would be no incentive in the Treasury to pursue a sensible fiscal policy because it would know that it was not responsible for inflation. All inflationary problems would be dealt with by the Bank of England and, again, there would be a recipe for higher interest rates than would otherwise be necessary.

In conclusion, the amendment seeks to enable that conflict to be sorted out, and to enable the Treasury to write to the Bank of England to put on the record how this inherent conflict, which arises from giving the Bank of England independence, should be resolved by those responsible for Britain's economic policy.

Dr. Cable: This is the best opportunity to say something on the substantive economics of the issue rather than on the constitutional issues that we dealt with before. I intend to speak against the amendments.

Clause 12, which relates to economic policy in general, has just been read out and it makes it clear that the Bill provides for multiple economic objectives. Clearly, if there is an emergency and large-scale unemployment, the Chancellor has powers under the Bill to give employment and growth priority. That flexibility is built into the legislation.

My main comments relate primarily to the speech by the hon. Member for Great Grimsby (Mr. Mitchell). He spoke at some length about sterling and the problems of exchange rates. We have heard more and more about the problems of sterling in the House. Treasury questions are increasingly populated with questions on that subject.

I am probably one of the relatively few people in the world who claim to have read the hon. Gentleman's book on the subject, which I think he wrote with a former Member who has now emigrated to New Zealand. It was an eloquent book, but it had throughout it a fallacy that he has perpetuated this evening, which is not distinguishing between the real and the nominal value of the exchange rate--an important distinction. It is perfectly possible to maintain the competitiveness of one's exchange rate while the value in the markets--the nominal value--is appreciating. That has happened in Germany where, during the past 30 years, the exchange rate has appreciated from DM11 to less than DM3 against sterling. For the most part, German exporters were more than able to maintain--or more than maintain--their competitiveness with the United Kingdom because we had an appallingly bad relative rate of inflation. If we think about real exchange rates rather than nominal rates, the problems raised by the hon. Gentleman are simply not applicable.

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The hon. Gentleman is on sounder ground when he worries about the particular problem that we have now of an exchange rate that is overshooting in the markets. Overshooting in the markets occurs for one of two reasons. One we saw during the early days of Mrs. Thatcher and another in the early 1990s which directly arose from the lack of credibility of those who were carrying out monetary policy. We had a period of lax control of money, a very high rate of inflation and then, over-compensation through high interest rates. The whole purpose of the legislation and of an independent central bank is to prevent such a problem from arising again.

Sterling is also very high because of the EMU premium. We have consistently argued with the Government that they should not procrastinate over EMU membership, but should get on with having a referendum and consider at least early entry, as that would shorten the transition to our having stable exchange rates in relation to European countries. As long as the delay persists there will be uncertainty and an exchange rate premium, because the ecu will trade at a relatively soft rate. In other words, it will be more competitive than sterling would be on its own. The Liberal Democrat argument to deal with that problem is that the sooner we proceed to EMU, the sooner we shall eliminate many of the problems of volatility and over-valuation that have been described.


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