It is a crucial feature of our Bank of England’s independence that was not always remarked upon. But it is nonetheless required that when inflation deviates significantly from the agreed target, there must be an exchange of open letters between the Governor and the Chancellor explaining the aberration.
In all the time Gordon Brown was Chancellor, the Governor never had to put pen to paper. So it is a little surprising that Osborne has seen a whopping 23 exchanges of letters, with inflation having at times shot above and – as now – fallen short of the steady-as-she-goes inflation target of two percent. It says a lot about the current government’s stewardship of the economy that what was once inconceivable has become routine.
What does this letter-writing imply? Turbulence.
There is no absolutely correct rate of inflation. Rather, the reason for the letters is this. An economy that’s either overheating or slowing down at too quick a pace is heading for trouble. Too much inflation or too much deflation is a disincentive to investors, consumers and employers alike. That’s why we aim for consistent, moderate growth. That is, economic stability.
So what’s gone wrong this time?
Well, the Governor’s letter does not make comfortable reading. Our low inflation is caused by a range of factors, largely based on sharp falls in commodity prices, especially the oil price crash and low cost of food and drink. Mark Carney also points to low pay growth and poor productivity as underlying causes.
And this is off the back of falls in sterling against both the dollar and the euro over the last few months as the EU referendum casts a shadow over our economy.
Some people – the Brexiteers perhaps– might say this matters little. Richard Tice from Leave.EU has argued that falling currency just means that our exports get cheaper, which helps manufacturing. Falls in sterling, they claim, are more a blessing than a curse.
Well, to a certain extent, there is a little truth in that. But of course our exports are only cheaper relative to the cost of our imports. Effectively, when sterling falls in value we are all poorer.
If sterling were to dive by 20 per cent, as the National Institute for Economic and Social Research (NIESR) predict in the event of Brexit, then commodity prices would rocket, hitting ordinary families who are already struggling due to poor wage growth. Not only that, but NIESR predict this fall in sterling would have a knock on effect on growth, with our economy 1 per cent smaller in 2017 and 2.3 per cent smaller by 2018 than it would have been if we stayed. The Bank share this view, with Carney warning of a “technical recession” if the Leave side win.
In fact, it’s not only this possibility of a crash that we have to face. It’s also the reality of the damage already done by the referendum. According to Carney: “The evidence… suggests that roughly half of the 9 per cent fall in the exchange rate since its November 2015 peak might be accounted for by referendum effects, including uncertainty about the outcome together with concerns that a vote to leave might reduce the openness of the UK economy and its long-run potential supply”.
Osborne will brandish the Governor’s letter as a weapon against the Out brigade, and rightly so. But Carney’s comments reflect as much on the man he is writing to as anyone else. A chancellor who has tried to anchor his reputation on commitment to economic stability and a famous long term plan, but who has risked the biggest shock to our economy in years in order to satisfy short term goals.
Looking at the damage done already and the dire forecasts ahead has to make you wonder what on earth Osborne and Cameron have been doing playing around with our economic stability like this. If, as I hope, we vote to stay firmly in the European Union, our economy will still likely have been damaged by this referendum. That is now the best case scenario.
At worst, a device whose purpose is nothing more than Tory party political management, could end up costing each and every one of us. It has already made us all poorer, and could make us poorer still. And what for? Because Cameron couldn’t stand up to his own party obsessed more with the bogey man they see Brussels as than the wellbeing of their own citizens. Cameron may well go down in history as the prime minister who held three referendums in order to keep things the same but, even if he succeeds for a third time, the consequences of his shameful game-playing will reverberate around the economy for years to come.