A ‘balanced recovery’ needs a better balance of payments

While policymakers focus on house prices and rate rises, a few lonely voices are raising growing concerns about net exports

For obvious, but different, reasons, savers and borrowers are becoming almost obsessed by the speculation about the timing, and extent, of the next rise in interest rates.

The recent launch of the Bank of England’s February inflation report was accompanied by much discussion of what the Bank thought it was really up to – always assuming that that venerable institution knows itself.

During a secondment to the Bank many years ago, I soon realised that it was a mistake to say “the Bank of England thinks this or that” because there was a multiplicity of views available to the governor at any one time. In those days, there was plenty of inflation – peaking at 24.2% in 1975 – but no inflation report.

The inflation report was introduced under the chancellorship of Norman Lamont in 1992-93, after the fiasco of Black Wednesday in September 1992, when the pound was humiliatingly ejected from what was then the European Exchange Rate Mechanism (ERM), the precursor to the single currency.

Membership of the ERM had been the latest in a long line of policies aimed at curing Britain’s propensity for wage inflation. In fact, the cumulative effects of Margaret Thatcher’s assault on trade union power, and the impact of the addition of hundreds of millions of workers to the world’s labour force (globalisation) has dealt a devastating blow to the bargaining power of the British workforce.

It suits the champions of “independent” central banks to foster the belief that it was the central bank that had the power to control inflation. And it was understandable that British policymakers should have decided to focus on the battle against inflation by directing the Bank to publish an “inflation report”.

The myth of central bank “control” of inflation has to be set against the reality that, for some years until very recently, import prices and the impact of the devaluation of the pound in 2007-09 meant that many a press conference conducted by the previous governor, Mervyn, now Lord, King, was an exercise in explaining why the Bank could not achieve its inflation target.

Indeed, as King often conceded, to have tried harder to hit that target would have had an even more deflationary impact on economic demand than had already been inflicted by the banking crisis.

In practice, the Bank was in those days being more pragmatic than the strict letter of its statutory duties would have had us believe. But the economy was painfully slow to recover, notwithstanding the various monetary stimuli being applied – including prolonged low interest rates, open market operations to boost liquidity (“quantitative easing”) and other initiatives.

Hey presto, Lord King was succeeded by Mark Carney, along came “forward guidance” – and suddenly there was, indubitably, an economic recovery, albeit a very lopsided one.

There was nothing original about Carney’s commitment to keeping interest rates at historic lows until there was a marked impact on unemployment. This was central casting stuff, straight from the handbook of Ben Bernanke, then the chairman of the US Federal Reserve.

One of Carney’s catchphrases was “escape velocity” and the quest for it. Escape to what, may one ask? A well-balanced recovery, or merely a return to bad old ways?

Someone who evidently fears it is a return to bad old ways is that indefatigable campaigner Adair Turner, one of the failed applicants for King’s job.

Among his many criticisms of modern capitalism, Lord Turner is concerned about the destructive effects of sudden, and vast, movements of capital.

Now, most attention in relation to interest rate changes seems to have been devoted to the consequences of a continuing boom in house prices, or – much analysed by the Bank in its latest inflation report – the policy response when the economy runs up against limits to productive capacity.

However, there is another consideration that makes me nervous. As Carney conceded at his recent press conference: “Weak world demand and the appreciation of sterling [by up to 10% since its post-devaluation low] will hold back the expansion of net exports.”

“Net exports” is the phrase used to describe “exports minus imports”. It is truly remarkable that the UK’s current balance of payments deficit was running at 5.5% of gross domestic product in the third quarter of 2013. The Bank’s analysis implies that this will get worse.

When, at a recent meeting of analysts in the City, I raised the question of the balance of payments, one of the younger economists said: “Oh, nobody worries about that sort of thing these days.”

I wonder. We now know that the governor and the monetary policy committee are emphasising the importance of a whole range of economic indicators in their attempts to guide the markets, not just the unemployment figures (although I think their previous approach was not quite as unsubtle as often made out).

My suspicion is that Carney, as a long-time student of the British economy, is as worried as I am about the underlying balance of payments position. And I hate to imagine what would happen if Turner’s feared capital movements turned against the UK.

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