Britain: A Rate Rise Is The Wrong Medicine

When Britain's Labour government came to power in May, Prime Minister Tony Blair and Chancellor of the Exchequer Gordon Brown got kudos for granting the Bank of England independence in setting interest rates. It was a clever move. For one thing, since the outgoing Tories had juiced up the economy in a desperate effort to stay in office, a return to tighter credit was inevitable. And an independent central bank would deflect criticism from the new government. For another thing, if rate rises choked off Britain's steamy growth--forecast to come in at 4% for 1997--a slowdown would come early in the new administration's tenure. That would give voters time to forget it by the time Blair calls new elections, probably in three years.

But the Bank of England might think about taking a leaf from U.S. Federal Reserve Board Chairman Alan Greenspan's book. America's long-running expansion is due in part to the Federal Reserve's rather laissez-faire attitude--even though Greenspan has occasionally issued warnings about looming inflation. The U.S. growth rate has hovered near 4% for the past four quarters, while inflation has actually fallen. In America, higher productivity, a growing service sector, and leaner, meaner factories have combined to lower the point at which the wage and price pressures kick in and boom turns into bust.

The Bank of England is raising rates at a time when producer prices are actually falling year on year. Housing activity has been capped, and industrial production is sluggish. In addition, the Asian crisis is now coursing through Latin America and Eastern Europe and is certain to lower global growth in 1998. This will surely drag down Britain's growth rate in the months ahead, puncturing any would-be inflationary bubble.

Britain's central bank should therefore ponder whether or not it is tightening monetary policy at precisely a time when the economy is already poised to turn down. Britain may not have all the conditions necessary for a "new economy." But its central bank should be prepared to err on the side of growth.

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