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Lord Higgins: My Lords, I am grateful to the noble Lord for allowing me to intervene. He talks of the Bank of England controlling monetary policy. Would it not be more accurate to say that it is controlling interest rate policy? The two are not the same. As regards monetary policy--the control of the money supply--that appears still to be under the Treasury.

Lord Desai: My Lords, I thank the noble Lord for that intervention. In modern financial markets no one

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controls money supply. It is very much influenced by what various financial institutions decide to do with financial innovations. As we discovered during the great monetarist days of the 1980s, with M1, M2, M3, M4, and so on, the monetary authority is no longer in charge of the money supply--perhaps base money but very little else. But it can control interest rates. However, it is only one instrument. Therefore it can have only one objective. Once one sets inflation as a target, it will use interest rates to control inflation. But one cannot add other objectives. The Bank of England or the Monetary Policy Committee does not have the instrument to pursue other objectives.

One of the few things we know in economics--we do not know many--is that one has as many instruments as one has objectives. Unless one hands over economic policy completely to the Bank of England Monetary Policy Committee, that committee will not be able to achieve more than one objective. It may be that the objective should not be control of inflation; that is another issue. The objective may be to ask the Bank of England to achieve full employment. I do not know how it will do that, with the only instrument being interest rates. That is not a good instrument for pursuing that objective. But given that the brief of the Bank of England is to control inflation by interest rates, there is still a role for a fiscal policy for short-term stabilisation.

This is an intellectual argument; it is not a party political point. There is a substantial body of theory in favour of what the Chancellor is doing, although I disagree with it. I believe that there is still scope for fiscal policy in the short term to do various things that monetary policy cannot do to stabilise the economy. I think that the disagreement will continue until some future date.

In the Comprehensive Spending Review my right honourable friend rightly set out the long-term public finance framework--what economists call the steady state. But there is a great deal of misunderstanding about this. The Comprehensive Spending Review does not tell you what will happen year on year. For example, the cyclical component is longer anyway. The cyclical component will obviously be rather large. The surpluses of £7 billion, £9 billion and £11 billion are the long-term steady state surpluses. I would expect--I am sure my right honourable friend knows this too--that the outcomes on both expenditure and revenue will not be as laid down in the Comprehensive Spending Review because that is a long-term picture.

As the Chancellor pointed out in his November Statement, we shall have a slow down of the economy. The recession in the economy was forecast as long ago as November. It has nothing to with the Asian crisis but with other issues. However, given that there will be a slowing down of the economy--we do not know whether it will be a soft or a hard landing--some of the surpluses may be absorbed by cyclical spending and we may have to borrow. Alternatively, the surplus may be larger than expected. But the Comprehensive Spending Review involves the steady state picture of the economy for the next three years; and I believe that the actual outcomes will be different because the economy will not be in a steady state. It never is. If my right honourable

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friend achieved his great dream of eliminating boom and bust, I suggest to the noble Lord, Lord Marlesford, that he would be eliminating capitalism. Perhaps it will require socialism to have an economy of no boom and bust, but while capitalism lasts we shall have a cycle--and a cycle will be our problem.

Today we face the difficulty that we are not sure whether the recession will be a soft or hard landing. Some noble Lords may have seen an excellent article by Mr. Gavyn Davies in the Independent on Monday. He pointed out that it depends on whether one thinks of the long-term rate of growth of the economy as 2.75 per cent. or 2.25 per cent. Noble Lords often make critical remarks about economists. They must understand our problem. Even meteorology has more resources for data collection than the economists. We shall not find out where the economy was in July 1998 for about six months. One is asking economists to drive a car on a rainy night with fog, with no steering wheel and almost no indication of the speed of the car. When I was young I used to think that I could build mathematical models that would precisely control the economy. The older I get, the less faith I have in such things.

Lord Howell of Guildford: My Lords, the noble Lord is making a fascinating speech. I appreciate a great deal of what he says. But if, as I am sure is right, the measurement of the economy is becoming more and more obscure, in particular in a global context, how can short-term fiscal changes--changes in taxation--influence it? That is what he argued at the beginning of his speech.

Lord Desai : My Lords, I am grateful to the noble Lord for that intervention. I always give the analogy of climbing a mountain in a fog: one step at a time is all right; I know where the next step is.

In my car I can do the next 10 feet or 10 yards but beyond that I do not know. We are asked to write out this fantastic map from here to eternity and say, "The short term will take care of itself." The long term is much clearer because we make assumptions--for example, 2.25 per cent., 2.75 per cent.--and draw nice little lines.

A myopic decision-making rule would perhaps be better if one is trying to stabilise the economy. I am not against making long-term plans but the basic problem for the British economy has always been that short-term stabilisation has defeated Chancellor after Chancellor.

I should like to say a word in that respect. I referred to the article by Mr. Gavyn Davies. He said that much depends on what we thought the long-term rate of growth would be. To say that if the economy is fast-moving it will be a soft landing and if it is slow-growing it will be a hard landing, is correct but not good enough. I should like to argue that mere micro-economic aggregates are misleading us about where the economy is. It is not that the economy is growing faster or slower but that there are imbalances in the economy. Consumption is growing too fast and

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investment is not growing fast. Services are growing and manufacturing is not. The south east is prospering and the north is not.

Monetary policy cannot tackle these problems. It is not possible for the Monetary Policy Committee, even given infinite wisdom, to do anything about that with a single interest rate. We need a combination of a variety of regional policies and environmental policies and perhaps a little thinking about the exchange rate if we are to tackle the problem of unemployment in the economy to which my noble friend Lord Bruce of Donington drew attention. I do not believe that there is a single natural rate of unemployment in the economy. There are a variety of natural rates in the economy and they depend on what we are able to do by way of structural policies.

In conclusion, I should like to say that it has been argued that somehow unemployment could rise because of wage bargaining. Many noble Lords have pointed out that it is not wage growth that matters but wage growth relative to productivity growth. So it is the growth of unit labour costs that matters rather than wage bargaining.

I believe that Professor Robin Marris pointed out, when the Monetary Policy Committee last met, that the growth of earnings depends very much upon technical matters, like how one treats bonuses. If one strips bonuses out, the wage growth is much lower than if one keeps bonuses in. What really matters here is not wage growth but whether the economy is able to sustain outward growth and employment growth. As soon as we stop having employment growth one may suspect that something is going wrong.

I believe that one of our problems is an over-valued exchange rate. I do not think we should start debating the lack of productivity growth in manufacturing. Even with the best of productivity growth you would not be able to employ people if the exchange rate is over-valued. That, perhaps, is something we cannot do much about. But I believe that if we are ever to join a single currency, we will not join at the present level of exchange rate. We may be able to join when it gets nearer to 2.70. I know that my noble friend is becoming impatient and so I shall sit down.

6.55 p.m.

Lord Jacobs: My Lords, I understand that I am speaking in what is known as the gap. I have only been here for nine months and I only learnt about it today. I apologise and I shall not detain your Lordships for long.

I should like to begin by saying that I echo the words of the noble Lord, Lord Desai, concerning the time when this House debates the Finance Bill. It was a great shock to me, when I arrived nine months ago, to discover that Finance Bills, monetary matters and even main economic matters play a small role in this House and that there is no authority or power for us to do anything other than perhaps occasionally debate them, as on this occasion, far too late to have any influence.

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That came as a surprise to me. This House probably has more industrialists and business people of experience than the other place. Therefore, I should have thought that they would at least have something to contribute. That is as it is, but maybe it will be possible to debate such matters at an earlier time in future.

Broadly speaking, I agree with the Government's budget policy. I approve of their economic stance from the day they took power. They were still faced with a £20 billion budget deficit and their prime objective was to maintain a tight fiscal stance and to reduce that deficit as rapidly as they could.

The Government have been criticised in some quarters--not, I am glad to say, here tonight--for proposing to increase public expenditure at a significant rate for the next three years. Having maintained a tight fiscal stance for two years, their rate of increase is not that great, taken over a five-year period. The previous Government increased over five years by 2¼ per cent. a year. This Government are proposing taking five years overall to increase public expenditure at the rate of 1¾ per cent. a year. So their growth in public expenditure is slower. But what they are doing is at least letting public expenditure grow when the budget is in surplus rather than deficit. That is something for which I strongly commend them.

I have one criticism of the budget. I should like to echo the words of the noble Earl, Lord Dartmouth, regarding capital gains tax. I confess that I, too, am a chartered accountant, although not practising these days. However, I helped to advise one or two people on the new provisions for capital gains tax. Frankly, the principles that they proposed were extremely good, that is that we should have a short and a long-term capital gains tax. With that I heartily agree.

However, when they take away indexation of capital gains tax they might as well have left it alone. The net effect of the two, if you compare one with the other, is very little indeed. This is a country of fairly low direct taxation. It compares favourably with America except in one respect, which is capital gains tax. There, we are now significantly worse off. We were not when we had indexation; we compared reasonably, although we had a much higher rate of tax. I hope, come the next budget, that the Government will have had enough representations--or rather will have listened to those representations, as they will certainly receive plenty--and will improve the situation next time.

The area that I should like to comment on does not directly come into the budget but has been referred to by several noble Lords earlier; that is, the question of the role of the Monetary Policy Committee.

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