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The UK finds itself somewhere in the middle between Iceland and the reserve-currency countries—the United States and the eurozone. It can be plausibly argued that we are closer to Iceland because sterling is not a major global currency to speak of. We are very minor players on the global scene. On the other hand, we have far more credibility than Iceland, and, because of that, the Bank of England can get over the problem by arranging swaps and credit lines with other central banks. However, the cost of that is considerable. Having to rely on such arrangements will place the City of London at a competitive disadvantage. Is it a loss of competitiveness that the City can afford? What would happen if we lost credibility because of a collapse of sterling?

Other countries which thought that they should preserve their economic independence, like Denmark and Sweden, are now seriously reconsidering membership of the eurozone. We now have to face the question: can we maintain a successful world financial centre without being a member of a major reserve currency area? If not, the only choice for us is the eurozone. Euros are likely to be a lot safer and more stable than pounds.

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5.53 pm

Lord Griffiths of Fforestfach: My Lords, I remind the House of my interests that are relevant to the subject, which are documented in the Register.

The UK economy is in recession, inflation has risen to more than 5 per cent, unemployment is rising, house prices are falling and repossessions are increasing. This is causing great pain to many people and households in this country. I have no wish to detract from the seriousness of the present recession, but it is important to maintain a proper perspective. The media talk of meltdown and global collapse. In my judgment, we are not entering another great depression. Business cycles are endemic to market economies; they have been documented since the mid-18th century.

The great depression of the 1930s, which followed the Wall Street collapse of 1929, was exceptional by any standards. Between 1929 and 1933, real output fell by one-third in the US and 10,000 banks went bust and, between 1931 and 1941, unemployment averaged 25 per cent. At present in Britain, unemployment is 6 per cent; if it increased to 3 million, it would represent only 10 per cent or 11 per cent. The US Federal Reserve through mismanagement reduced the money stock by one-third. At the same time, countries pursued beggar-my-neighbour policies through competitive devaluations of their currencies, the imposition of tariffs, import quotas and non-tariff barriers.

Today, the situation is entirely different. The UK and US Governments have taken decisive action to deal with the banking crisis and it is clear that the action has had an impact. I applaud the Government for that. The Bank of England has accepted its role in maintaining financial stability. Central banks have acted in a co-ordinated manner by providing increased liquidity to the banking system. Countries are not pursuing beggar-my-neighbour policies. President Bush has called a meeting for later this month—the so-called Bretton Woods 2 meeting. I share the scepticism of my noble friend Lord Lawson about the outcome but, on the other hand, the meeting will consider a more appropriate regulatory framework.

All those things should give us cause for hope, even in this difficult situation, especially when one compares it to the early 1990s, when inflation reached 8.5 per cent, mortgage rates were 16 per cent—they are now just above 6 per cent—and we were constrained in what we could do by our membership of the ERM. Although the present recession is painful, we have every reason to believe that we will avoid serious deflation and anything approaching a great depression.

In these circumstances, what should the Government and the Bank of England do to try to reduce the scale of the recession without creating conditions for rising inflation in a few years? I suggest three measures. First, the Bank of England must cut interest rates now. This is a crisis and we need bold action. In my judgment, there should later this week be a cut of at least 1 per cent. At the same time, the Bank is right to be concerned about future inflation, because of the explosion that we have seen and are seeing in public borrowing. At some future date, the Bank will come under great criticism, because it will wish to protect the currency, and the Government will be forced to

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take the difficult decision to cut public spending, to raise taxes or to abandon their inflation target. That is an issue for the future. For the present, it is imperative that we cut taxes.

The second measure relates to the banks. The noble Lord, Lord Forsyth, made an eloquent statement on this, as did other noble Lords. The Government were absolutely right to take drastic action last month to kill a banking panic. It was right that, when the Government rescued the banks, the shareholders should have borne a significant cost. However, I ask the Minister whether the draconian terms imposed on the banks at a time of financial emergency should be revised. The Government stopped the banking panic. The challenge is how to get bank lending to small businesses going again, as the noble Lord, Lord Bilimoria, reminded us. Asking the banks to lend is fine, but the more that you can align their commercial interests with government policy, the better. In my judgment, that means allowing them to pay dividends and removing many of the controls that are imposed on them. That, I think, would allow them to take better decisions.

Thirdly, there is Treasury policy. Spending and borrowing will clearly rise in the recession. There is an urgent need to get back confidence and get money back into people’s pockets. I doubt whether infrastructure projects are really appropriate, due to the planning, consultation and administration involved, but it seems to me that one thing could be done—whether within the existing framework or as a separate, almost Keynesian, measure—which is to cut taxes and, in particular, national insurance. National insurance is a tax on employment: it hits employers and employees. At a time when unemployment is rising, the announcement that rates would be cut in the Budget would give business one less reason to shed labour and employees one more reason for reducing expenditure less.

In conclusion, we face a serious recession but not, I believe, a great depression. We must all, including banks, take responsibility for our part in creating it, but if the Bank of England and the Government act now, I believe that they can reduce the severity of the recession to the benefit of the whole nation.

6.01 pm

Lord Peston: My Lords, one should never wish for anything because one’s wish may come true. On the Tuesday after we came back from the Recess, I exploded with rage, demanding a debate on the economy, but was told by the Chief Whip that all the time in the overspill was dedicated to Ministers and that I should forget about it. Then, to my amazement, with virtually no notice, here we are. I have to tell noble Lords that there are nearly 30 more speeches to go and I am already exhausted. I am not saying that we have reached the point of negative marginal utility, but we cannot be far away.

The world has been struck by a major shock, focused largely but not entirely on a banking panic. Our Government have reacted promptly and decisively to intervene and to mitigate its effects. They have acted in a non-doctrinaire way, as is indicated by support for aspects of the Government’s policy from all round the

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House. It is interesting to see how the United States Government have acted in a similar way, as have leading members of the European Union. Most interesting of all is Professor Bernanke, the world’s leading expert on credit and credit crunches. Professor Bernanke has intervened in the American economy in, again, a totally non-doctrinaire way. He was appointed by President Bush to be head of the Fed on the grounds that he was a dyed-in-the-wool monetarist, but he has had no difficulty at all in supporting the same kind of Keynesian expansionist policies as we have in our country. That is much to be applauded. If I may use an imperfect analogy, when the patient—in this case, the economy—is dying, you resuscitate him and argue about his lifestyle and what he should have done only when his life has been restored again. That is why the Government’s policies have been absolutely necessary.

Despite the intervention, we all agree that in the short term all the leading economies will go below their underlying rate of growth and some—notably the US and the UK—will experience negative growth. There is no doubt at all about that. Whatever the Government’s intervention does, it cannot stop that happening or unemployment rising to some degree. That reality has to be faced. It is a double reality because, as has been pointed out, it is often the weakest and poorest who suffer the consequences, but that has to be accepted.

In terms of predicting all this—by which I mean serious economic predicting and not people going around saying “Woe is me” all the time and then, when the worst happens, saying “I predicted it”—I can say categorically that I certainly did not predict what has happened. My view was that there would be a slowdown but I certainly did not predict, say, in May that a recession would occur. Right at the bottom of the blue fan chart in the inflation report of the Bank of England is something that means, “It’s possible but completely unlikely that there will be a recession”. However, that was not the mean position. The mean position was “clearly slowing down” rather than a recession. I did not get it right and therefore I do not criticise others who may not have got it right.

The question that people keep asking me is whether the Government’s policy will work. Because of the expectational effects—the uncertainties and the confidence problems—you cannot say for certain that it will. You can say that you hope that it will but you cannot say for certain that it will. Twenty-five years ago, Professor Bernanke devoted his PhD thesis to the effects of uncertainty on the economy. He demonstrated in some brilliant work that, if you get too much uncertainty, no policy whatever will work. I can only hope that we do not now have sufficient uncertainty in the economy to lead to that conclusion.

In this connection, I notice that the newspapers, apart from discovering Keynes, have discovered Karl Marx. Karl Marx certainly believed that free-market capitalism would destroy itself, but he thought that the route to that would be via the class struggle. He did not believe that it would come about through self-destruction by the leading capitalists. So, in one sense, Marx may have predicted—I hope, wrongly—what was happening, but he certainly did not get the explanation right.

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If we get through the current crisis, what will happen next? I wish to make a couple of points in that regard. First, I shall mention the noble Lord, Lord Lawson, who referred to the need to raise the propensity to save. That enables one to focus on the difference between the short term and the long term. An increase in the propensity to save in the immediate future would be disastrous for the economy, because no one would want to borrow those savings and the economy would go not into a recession but into a depression. Equally, the noble Lord, Lord Lawson, is right that, once we get back on track—once we are at what I call full employment—it is vital that we increase the propensity to save. In that sense, we come to the other aspect—

Lord Lawson of Blaby: My Lords, I said that it has to happen because consumers’ balance sheets need to be rebuilt. It may have an undesirable consequence but the savings ratio will go up simply by people not borrowing or getting into debt any further. Surely he agrees that that is going to happen.

Lord Peston: My Lords, the point that I am trying to make is that that is the medium-term solution that we should be aiming at, just as the Government’s propensity to save also has to be put back on track in the medium term. However, in the short term, that is the last thing that we need. The trick is getting from the short term to the medium and long term.

In the long term, the fundamental question is whether to go for less public expenditure or for raising taxes. I have tried endlessly in your Lordships’ House to persuade the Official Opposition to stop waving their hands in the air and to tell me whether they are capable of taking serious decisions on the future of public expenditure. However, every time I ask them, they just wave their hands in the air. As I said on the wireless the other day, I assume that the present Government will be in power for the next round, when they will have to take some tough decisions on public expenditure. Equally, were there to be a national disaster and the Opposition became the Government, the idea that they would not have to take similar decisions is preposterous.

I must come to a conclusion. I have not talked about the banks because I will be able to do that when we consider the Banking Bill and I have not talked about some of the detail on the short-term package because we will have a chance to do that when we consider the Pre-Budget Statement. Noble Lords can look forward to hearing me speak on both those matters.

6.10 pm

Lord MacGregor of Pulham Market: My Lords, one problem with speaking at this stage of the debate—it must be far worse for those further down the list—is that so much of what one wanted to say has already been said. I have had to totally rewrite my speech. I agree with much of what my noble friends Lady Noakes and Lord Lawson said, but I shall not go over that ground again as I had intended to, except to make three brief points on what has gone before.

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First, of course, I recognise that the blame for the current crisis does not lie only at the Government’s door. The Minister referred to the American background. I share the concern that the banking and financial communities are also culpable in that so many traditional banking practices were thrown out of the window in the search for greater market share, higher returns from ever more complex instruments and, yes, higher bonuses. I could never understand why securitising dodgy mortgages in a package made them less risky, as the underlying toxic nature of the ingredients remained the same. That was fine as long as the originator could sell them on quickly to someone else. The banks’ risk models proved faulty when liquidity dried up.

I also share the view expressed by the right reverend Prelate the Bishop of Chelmsford that one of the more unpleasant aspects of the whole situation is that top executives’ remuneration packages allow reward for failure. I support the need for that to be addressed, as indicated by the Government and supported by the ABI recently. The role of the credit agencies, on whose ratings so many lending decisions were justified, is being reviewed. That is absolutely right and I look forward to the results.

Secondly, I agree wholeheartedly that the slogan which will go down in history as the most crass is the Prime Minister's repeated boast that his Government had brought an end to the era of boom and bust. In fact, the Government were pursuing policies, in a temporary, very benign international climate, that would bring about an almighty bust. What is more—here I agree with my noble friend Lord Lawson—the very repetition of the point led many individuals in businesses to feel that they were safe to borrow more heavily than ever before. Imprudent lending, as he said, drove out prudent lending and imprudent borrowing drove out prudent borrowing.

Thirdly, I refer to the comments of my noble friend Lord Griffiths on the measures taken by the Government to deal with bank liquidity, which I too support. They are to help not only small businesses. I support what the noble Lord, Lord Bilimoria, said. I was actually the Minister who originally introduced the loan guarantee scheme, so naturally I support what he said. However, big businesses often find it very difficult to raise short-term finance in the current situation. It has been drawn to my attention that the Federal Reserve board has recently introduced a commercial-paper funding facility to assist commercial paper in the United States. Does the Minister feel that that would be a useful addition here too?

I turn next to the regulatory regime, on which there has been less comment in this debate. I realise that there are many with more expertise on the subject than I have, so I tread warily. I note that there has been much talk that there has recently been better co-operation and co-ordination between the Bank of England and the FSA, which leads me to wonder whether it was strong enough in the years leading up to the crisis when it certainly should have been. I noted that Sir John Gieve, in his address to the BBA’s annual supervision conference last week, said:

“What we have found in the last few years is that the sum of what makes sense at the level of individual institutions does not necessarily add up to what is needed for the system as a whole”.

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The report on Northern Rock found the FSA badly lacking in its supervision of what it regarded as one of the most high-risk firms. Was the heavy emphasis in the FSA on box-ticking for the “treating customers fairly” programme at the expense of properly assessing the financial risks of individual firms, which is just as crucial and perhaps even more so for the customers themselves? I wonder whether the FSA got that balance right.

I have often wondered why Santander seems to be so much less under media and market scrutiny than other banks. In the same lecture, Sir John Gieve referred to the “dynamic provisioning” of Spanish regulations. Are there lessons to be learnt there? I look forward to hearing whether the noble Lord, Lord Burns, has anything to say on that subject, as a director of that bank. Was sufficient attention given to systemic risk? Was the division between the FSA and the Bank of England, after all, a mistake? I look forward to the review of the noble Lord, Lord Turner, on that.

I want to say a brief word about pensions, following what my noble friend Lord Blyth said. Even if in due course markets recover, the much heavier deficits on most defined benefit schemes as a result of the crisis may well be the last straw for many companies and the last nail in the coffin after that first famous raid in 1997, to which he referred, for even more of those schemes. I am also concerned about the implications for personal pensions—I wish I could speak longer on that. The present crisis, combined with a very low savings ratio and high pressures on personal discretionary expenditure, means that the outlook for personal pensions is pretty depressing.

I was one of those who earlier strongly supported the PFI regime and I introduced one or two PFIs myself. However, I have been concerned for some time about the scale of the situation now. It is rather like off-balance-sheet financing: if it is not on too large a scale, it is very sensible. The scale of PFIs now is so large that I believe it is stoking up trouble for the future and affecting the public spending programmes because so much of the capital spending, about which the Government boast in education, health and so on, was done through PFI schemes so is not included in the borrowing-to-invest figures. I fear that the PFI schemes will make the future public spending problems even greater. It is future Governments and future generations who will pay for it.

That leads me to my final point: what happens next? Lower interest rates are fine. Will banks, in an attempt to increase margins, follow completely the downward movement in interest rates? Will that create further risks for sterling? Above all, will that last if the Government add to an already very high level of borrowing by attempting to spend their way out of a crisis, as they are apparently planning to do? Here I strongly support the view of all those who warn of the dangers of this. For this Government, spending our way out of the crisis now is dictated more by the political calendar than by economic needs, and the next Government will be left to face the bill.

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I am delighted that we have had this debate today, but it is in advance of the public spending review, which will greatly add to the figures and, I hope, to the government policies rather more than the Mais lecture which the Chancellor delivered last week. I very much hope that we will be able to return to this subject with a full-length debate on the Queen’s Speech, because that would be highly appropriate in the light of the public spending report.

6.18 pm

Lord Skidelsky: My Lords, I would like to follow the structure of the speech of the noble Lord, Lord Lawson, although my arguments and conclusions will be a little different from his: how we got to where we are and what should be done about it. On how we got to where we are, as I understand it, the noble Lord, Lord Lawson, chiefly blames the failure of banking supervision, which enabled the banks to lend recklessly. Of course, that is a large part of the issue. The whole world became vastly over-leveraged. Ten years ago the world stock of financial assets, stocks, bonds, loans and mortgages was equal to the total of world GDP. When the crisis hit last year it was four times as much and financial derivatives, which are claims on financial assets, were 10 times larger than that. It was like an inverted pyramid: the more claims were piled up on top of real output, the more wobbly the pyramid became and eventually it collapsed.

Lack of banking supervision is important, but another crucial part, which was not mentioned, was played by financial innovation. Very clever entrepreneurs—mathematical whizz-kids equipped with computers—invented instruments of increasing sophistication and obscurity, which enabled debt to expand exponentially. I doubt if the banks themselves understood what was going on, and regulators and supervisors would have understood even less.

The second cause of the boom-and-bust phenomenon was the global imbalances that had been building up in recent years, starting with the collapse of the first Bretton Woods system. The key point has been the accumulation of massive reserves by east Asian countries. The counterpart of the consumption glut in the West was the savings glut in the Far East. Exchange rate undervaluation by Asian countries was the policy weapon used to carry out the accumulation of reserves and export-led growth. These excess Asian savings have been shovelled into the housing bubbles of America and Britain not directly, but by enabling our Governments to pursue expansionary monetary and fiscal policies that fuelled an unsustainable credit and housing boom. For the past 10 years the United States has, in effect, had no budget constraint, and what was true of the country as a whole was true of companies and individuals who piled up debt on the back of constantly inflating house and asset prices. Therefore, lack of bank supervision is not the sole explanation of things that have gone wrong.

What should we now do? Beyond the rescue operations the Government have already carried out, it is not completely obvious to me. Everyone agrees that the bank rate should come down, but how many people realise that lowering the bank rate is not the same as

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lowering interest rates? If the banks, on account of their bad debts, are expanding their cash balances at the same time as the Bank of England is lowering its interest rate, or, for that matter, as the Government are buying shares in the banks, there will not necessarily be a drop in the price at which banks are prepared to part with their money. That may occur even if the bank rate drops to zero. That is not just a theoretical possibility—in the theory, it is called the liquidity trap—as the Japanese experience in the 1990s gave it some empirical support. If we go back for a moment to the 1930s, the policy of cheap money, which started in 1932, only started to work once recovery had already started. In other words, the horse was willing to drink by that time. That recovery was started by Britain leaving the gold standard in 1931. Today's equivalent is the depreciation of the pound, which is one of the more hopeful aspects of the current situation. Therefore, I do not agree with the noble Lord, Lord Taverne. Depreciation has always been a shock absorber. It is very necessary and is coming into operation now. Thank God, we are not in the euro. For that, I am willing to give considerable credit to the Prime Minister, who held out against it.

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