A disagreement on tactics, not strategy

ECONOMIC VIEW

ECONOMIC VIEW

By now the form of this particular Punch and Judy act is well established. The hapless Governor of the Bank of England puts forward his case for a rise in interest rates. The Chancellor clouts him good and proper - to popular applause. You'd think the Governor would learn, but no, up he pops again the following month only to be sent flying again.

The deadlock between Kenneth Clarke and Eddie George that started in May is widely expected to continue in today's encounter. The official line is that it is all a matter of judgement on decisions that are "finely balanced" and where any Chancellor is perfectly entitled to take issue with the Governor. But then they would say that, wouldn't they?

The cynical view is that there is a lot more to the stand-off than is being admitted. The Governor is cleaving to an inflation target the Chancellor has, in effect, junked. Come what may, political imperatives will lead to an abandonment of a tough anti-inflation stance in the run-up to the next election.

No one ever went bust by under-estimating popular taste - and much the same holds true for politicians: no one goes far wrong in underestimating the Darwinian drive for survival in Westminster. Politicians will do whatever they think necessary to keep in power. But the rift between Kenneth Clarke and Eddie George, while undoubtedly there, does not run quite so deep as the cynics contend - for the best or worst of cynical reasons.

Start with the target for underlying inflation. In their evidence to the Treasury Select Committee earlier this month, both the Chancellor and the Governor were keen to convince MPs that they were singing from the same hymn-sheet. The hymn in question is that the Government is firmly committed to an inflation target of 2.5 per cent or less, a goal generally interpreted as about 2.25 per cent. Their protestations were less than persuasive. The Chancellor did subtly change the inflation target in his Mansion House speech from the one set out by Norman Lamont in October 1992 for the end of the Parliament. In effect, he raised the midpoint of the target from 1.75 to 2.25 per cent and the upper limit from 2.5 to 4.0 per cent.

However, the relaxation of the target was in all essentials more apparent than real. For the initial range set by Norman Lamont was unrealistically tight, implying a tougher target even than that set by the Bundesbank and making no allowance for the natural tendency for inflation to vary during the economic cycle. The Treasury was quite right to bow to reality. Mr Clarke would have done better to admit that in his Mansion House speech rather than juxtapose the two targets as if nothing had changed.

The formal position is that the Governor accepts the new target and expects the Bank's policy advice to be judged by reference to it. Despite this, few doubt that the Governor is passionate about low inflation in a way in which the Chancellor is not. It was noticeable in his reply at Mansion House that he did not mention the 4 per cent upper limit.

However, even if there is a continuing disagreement between the Chancellor and the Governor over the depth of their commitment to low inflation, there may be less to this than meets the eye. For the crucial question is whether it is actually in the Government's interests to take big risks with inflation in the run-up to the election in order to stoke up a short-lived boom.

The answer is almost certainly that it is not. The goal would be to increase the amount of money in people's pockets. At present the Treasury expects real personal disposable income to grow by 2 per cent next year. Yet even if this is boosted with generous tax giveaways, it will still increase at a much more subdued rate in 1996 and 1997 than it did in the 1980s, when there were three years in which personal income grew by between 4.5 and 6 per cent.

The gain from a loosening of policy would therefore be on nothing like the scale of previous pre-election booms. Yet the danger would be that the Government would go into that election with inflation on the rise and getting out of hand again. The Government would come under assault from industry - the CBI made clear only this week that stability was what industrialists wanted above all - and it would come under attack from Labour, now reborn as the party of price stability.

Better in these circumstances to make a virtue out of necessity: present a "steady as she goes" posture and capitalise upon a proven record of sustained low inflation. The political rhetoric about the merits of stability simply acknowledges the realities of an economy which is still adjusting from the debt-led excesses of the 1980s.

The Government's commitment to low inflation is therefore more than cosmetic: it is one of the few cards the Conservatives can play. What that means is that the disagreement between Kenneth Clarke and Eddie George is more about tactics than strategy, the timing of measures than the measures themselves. Above all it is more about the immediate political pressures on a Chancellor than a Governor.

The decision to keep base rates on hold in May was almost certainly taken on the hoof by a Chancellor under extreme pressure from a Prime Minister who was fighting for his political life following the disastrous local election results. It traded short-term political gain for long-term political loss, in that it was in the Government's interest to get any further political pain from interest rate increases out of the way as early as possible.

The nub of the present disagreement between the Chancellor and the Bank is that this window of political opportunity may be closing. It will become progressively more difficult for Kenneth Clarke to sanction any further interest rate increase the closer we get to the election. Yet it may be the Conservative Party that ends up paying the price. If inflation does conform with the Bank's gloomy predictions, the final political judgement on the Chancellor's apparent triumph over the past three months may be that it was a pyrrhic victory.