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Mr. Tom Harris: Can the hon. Gentleman tell the House how the Liberal Democrats would engineer a devaluation of the pound to help manufacturing industry? I know that that is a very dangerous thing for any Government to do. I presume that the reason why the Liberal Democrats claim that they can do it is that they will never be the Government.

Mr. Davey: We have argued consistently—it is not a new argument but one that we have been making for many years—that if the Government had a positive approach to joining the single currency and gave us an indication of when the referendum would take place, the foreign exchange markets would push sterling down to a competitive rate.

Mr. Harris: Fingers crossed.

Mr. Davey: The hon. Gentleman says from a sedentary position, "Fingers crossed"—

Adam Price: Signalling effects.

Mr. Davey: As the hon. Gentleman says, however, the signalling effects have been proven, not just in the case of the UK but in the case of Italy when it announced that the lira would join the single currency. There was a sensible, slow, gradual and sustainable depreciation, so that the lira could move in a competitive way into the single currency.

Directly after the general election, the markets perceived that the Government, who had kept their large majority, might be more positive about their approach to, and timetable for, joining the single currency, and the foreign exchange markets reacted to that by putting downward pressure on the exchange rate. The Treasury stepped in to say, "Hold on a minute. We have no

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intention of joining," and tried to scupper the rumours, and it was only then that the pound went back up again. That proves my point entirely.

The Government have failed to give a clear lead on the exchange rate and so must take the blame and the responsibility for many of the thousands of jobs that have been lost in manufacturing. Let us remember that 500,000 jobs have been lost in manufacturing over the past five years.

Rob Marris: I represent a constituency in the west midlands, the manufacturing heartland of the United Kingdom. In contrast to the hon. Gentleman's view, it seems to me that the cross rates between sterling and non-euro currencies show that the problem is that the euro is too low rather than that the pound is too high. Does the hon. Gentleman disagree with that analysis? If so, what level does he think the pound should be at?

Mr. Davey: When we carried out a review with a whole range of independent economists who were experts on exchange rates, we published a guideline on the sort of range at which the pound could join the single currency. We challenged the Government to provide their range and enter the debate. That is how we should start to consider and face up to the issue. The Government's failure to do that concerns me greatly.

Mr. Flight: Since the hon. Gentleman has focused on this territory, will he complete the story? The Chancellor and the Treasury are terrified that, if sterling were to depreciate significantly, inflation would be imported into this country, interest rates would rise and the housing market would crash. The Government would then become the most unpopular of all time. That completes the circle.

Mr. Davey: The hon. Gentleman is almost beginning to suggest a conspiracy theory which says that the Government are deliberately not acting because of the housing market. I am not sure that that is the case. The Government do not control interest rates; they rightly gave power over them to the Monetary Policy Committee, which has the difficult task of trying to judge the balance between the external side and the domestic side and to deal with the dilemma of domestic inflation in sectors such as the housing market and external deflation in the tradeable sector.

Mr. Flight: The hon. Gentleman has missed the point. The Bank of England will certainly continue to control interest rates; but given the state of the economy, the Government know that if they talk down sterling, inflation is likely to increase. If inflation increased, the Bank of England would be obliged to put up interest rates. If interest rates were put up in the current property market, with many people dangerously over-borrowing at low rates of interest, there would be the risk of a crash in the property market. That is the circle.

Mr. Davey: The hon. Gentleman is wrong. Many people in the Treasury and the Bank of England would like a readjustment of monetary policy in exactly the way that he describes—a lower exchange rate and a higher interest rate. That would probably be a much better

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solution. The Government could engineer that if their policies on the euro were much clearer, but the examples that I have given show that their failure to go down that route is leading them into a dangerous position in which the housing market is being allowed to overheat. That will store up trouble for the future.

Mr. Michael Jack (Fylde): On a point of detail, the Government in fact retain control of monetary policy by virtue of the fact that they set the target for inflation. Section 11 of the Bank of England Act 1998 requires the Bank and the MPC thereafter to hit that target. If the Chancellor wanted to affect the range of interest rates, he could, if he so wished, change the inflation target.

Mr. Davey: The right hon. Gentleman makes a valid point, and I refer him to the report of the Committee that debated the Bill. I served on that Committee and argued for target independence for the Bank of England, so that the Monetary Policy Committee could set its own targets instead of the Chancellor doing it—in the same way as the European Central Bank does. I argued that because if the markets think that the Chancellor may use that remaining power to set targets and thus affect interest rates and the exchange rate, that will undermine the credibility of the inflation rate.

Long-term interest rates show some evidence that we are still paying a premium in the UK. We have slightly higher long-term interest rates than many other of our competitor countries. That slight premium exists partly because the Bank of England does not have target independence. [Interruption.] If hon. Members wish to dispute that, I am more than happy to show them some of the figures that I have seen. I also refer them to the recent article in the Financial Times by Chris Huhne, a Liberal Democrat Member of the European Parliament.

Mr. Redwood: If the hon. Gentleman cares to check today's Financial Times, he will see that the long bond yield in Germany is slightly higher than the long bond yield in the UK. He has only to read it.

Mr. Davey: The House of Commons information document on economic indicators, which was published this week, shows that on 10-year Government bonds, the figure for the UK is 5, in the US it is 4.83, in Switzerland it is 3.21 and in Japan it is 1.25. My point is backed by the evidence in the latest publication from the Library.

The Government's rosy picture of the economy is complete nonsense. Indeed, the whole strategy behind the Bill is very worrying. In the Budget, the Chancellor increased his forecasts for the underlying growth rate of the economy. He did that to try to balance the public finances. By increasing the underlying rate of growth by just 0.25 per cent., the Chancellor found £4 billion or so over the forecast period.

The change in forecast is highly contestable, for reasons to do with the overall performance of the economy that I have discussed and, if one looks at the background documents published at the time of the Budget, the overall rationale behind it. On Second Reading, I asked why the Government had not chosen the central forecast from the Government Actuary's Department. The rationale for increasing the growth rate was that the population was increasing faster than had previously been expected.

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The Government relied on the report from GAD for that information. However, instead of taking the central forecast from that report, the Government chose a figure in the mid-range between the central forecast and the most optimistic forecast. By doing so, they tried to provide an explanation for increasing the underlying growth forecast.

I received no reply when I asked why the Government had decided to make that change. It was arbitrary and stealthy, and the only way in which the Chancellor could balance the books. I am concerned by that. The Government's positive spin on the performance of the economy is very worrying, because they are misleading themselves into believing their own public finance forecast.

I support the Government on one major change: the increase in taxation to fund the extra health spending, which is key to the Budget. My hon. Friends rehearsed the argument in favour of such a policy on Second Reading of the National Insurance Contributions Bill and elsewhere, although we would not raise the money in the same way. Income tax is our preferred route because it would be fairer and more efficient. It would not hit employers and would ensure that people who enjoy high investment incomes pay their fair share.

The fundamental question that the Conservatives have ducked is whether they support the extra money for the health service. That is the key consideration. We have campaigned for that increase in spending for many years. It is one reason why we voted against Third Reading of the Finance Bills in 2000 and 2001. It would be hypocritical to vote against Third Reading today because the Government have done what we have been calling for, albeit with significant differences. The basic thrust is right, however, which is why we support them.

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