One point of agreement between the more radical of Post Keynesian economic thought and the mainstream is that there should be little or no intervention in the exchange rate and that the pound should be allowed to float freely. However, whilst many Post Keynesian economists would argue this way, they would also not be in favour of being quite so concerned about the budget deficit which is behind the austerity drive favoured by the mainstream.
An exchange rate policy need not be in the form of an old fashioned peg between the pound and the dollar, or even a basket of currencies, at any one particular rate, but it could be that government tries to ensure that imports and exports are always close to being in balance and always is prepared to nudge the exchange rate either way to try to achieve that. At present the imbalance is approximately 4% of GDP which puts the UK as a whole into debt. Either the government or the private sector has to cover that. There’s no point there being a squabble over just who that has to be. But that is where we are now in our economic thinking.
So what are the options?
We can have a policy on the government’s deficit, the trade deficit and the exchange rate. We can have a policy on none of these or any other possible combinations of policies we care to propose. What we do have, currently, is a policy only on the government’s deficit (meaning it needs to be turned into surplus) which is not only not the best choice – it is just about the worst possible. We either should have a policy on all three or no policy on any.
As it is, we are just chasing our tail, and not really doing anything but put the economy into a tailspin when we try to reduce the government’s deficit by cutting spending and increasing taxes. We need a smarter approach and to look at the problem from another angle. We also have to ensure that we make a rational choice and not just indulge in wishful thinking. We cannot, for example, choose that the pound should be as high as possible, and the government’s deficit or the trade deficit should be as low as possible or even be a surplus. The numbers simply do not stack up.
One way to achieve a higher pound is to ensure that the UK Â is exporting goods and services that the rest of the world wishes to purchase and at a price which it is prepared to pay. Another way is to sell gilts and pay interest on them. At present, there is a good case to be made that the interest is very low on those gilts and we should sell as many as possible. If the Government does that it has to then recycle the proceeds into the economy by deficit spending.
So we need to understand our options and decide what we would like to do. The economic principles are nowhere near as difficult as many media and political mainstream economic pundits try to make out. If Liberal Democrat economic spokespersons explained the situation as it really was, they would not only get my vote at the next election but they would get many more too. Most voters are a fed up with the spin we’ve had from both left and right on the issue of ‘austerity economics’.
* Peter Martin is not a LibDem party member but has voted LibDem in previous elections.
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10 Comments
Nope
I agree Peter. The globalised free market crash in 2008 proved to be the perfect opportunity for George Osbourne to discredit labour economic competence and implement austere right wing Tory/Libertarian policy of minimal state involvement in the economy. Unfortunately it seemed that Nick Clegg, David Laws, Danny Alexander were just as enthusiastic for this as the Tories themselves ! The party seemed to have ditched Keynesianism completely making it look right wing in the eyes of the electorate.
I don’t like exchange rate targeting. For me, monetary policy is about interest rates and inflation. Anyone can add a or take away a decimal point to/from the pound and all you would get would be a load of admin work and contract re-writing. Some people have long-term fixed rate contracts. You can end up with currency wars too when nations with a lot of bonds or assets in that currency respond.
I feel quite strongly that monetary policy is not about exchange rates and I’ve never really liked it when people analyse them too much. Interest rates on the other hand, are very important.
Yes, it matters when the pound drops or rises, but when the pound drops because Boris says he wants to leave the EU, then the answer is to win the argument, not start playing with the currency.
Best regards
@ Eddie, Maybe I didn’t explain it clearly enough. But just to have another try:
a policy on the exchange rate doesn’t have to be a peg at, say, £1= $1.50 but rather the pound can be varied to ensure that imports and exports balance.
Of course the Govt doesn’t have to do that. We can have an imbalance as we do now. But if the imbalance puts the UK into debt then we have to sell bonds. So the trading debt translates into a general debt problem for the UK. That’s fine if we don’t worry about the debt but if we do then there’s a contradiction in our policy.
Petermartin, you’ve lost me. Interest rates are 0.5% and we’ve had three rounds of quantitative easing, what are you proposing to boost exports? More quantitative easing?
We need to be careful about currency devaluations because of fixed rate annuities and the much larger market of fixed-interest securities full stop. It can just create currency wars.
Eddie, You seem fixated on interest rates. Forget about them for a moment. If the UK had balanced trade there would be an equal value of goods and services leaving and entering the country. The government/central bank wouldn’t net sell its own bonds or net buy other country’s bonds.
If it was a net exporter there would be more money coming in from trade than going out. It would net buy other country’s bonds to balance the books. If it was a net importer there would be less money coming in from trade and it would net sell its own bonds to balance the books.
So how does a country choose to be a net exporter or a net importer? It simply chooses to be a net seller of bonds and an importer which pushes its currency up. Or a net buyer of bonds and an exporter which pushes its currency down. The net sellers of bonds acquire a liability to redeem those bonds which puts them into debt. The net buyers acquire a financial asset which gives them a surplus.
All this can happen even when interest rates are zero (or close to it) if the net sellers of bonds can find buyers for those bonds.
Hi Peter, you seem to know more than me about this. Why if a country is a net-exporter, such as Germany, do they have to buy bonds to “balance the books”? Can’t they just accrue currency reserves?
Regards
Eddie,
Bonds are currency reserves. Normally bonds would pay some interest so it would make sense for the central banks to buy bonds to collect that. So holding bonds is just like holding money in a savings or term deposit account. Holding cash is like having money in your current account. Bonds can quickly be sold for cash in any case which is just like moving money from one account to another.
Now that interest rates are very low the position is slightly less clear. Some bonds have a negative interest rate and some reserve accounts at central banks do pay a small amount of interest.
Thanks. Peter, I agree that if we have a trade deficit then we need to finance it, so that’s not good, but I just think the way to eliminate it is to build higher quality products.
Unless there’s evidence that other people are manipulating our currency, then I don’t really see the need to intervene in that area, besides with interest rates, which are a way to influence the money supply without increasing or reducing the monetary base (the physical and digital stock of money).
Are you talking about changing the monetary stock/base? Or perhaps just buying other people’s currencies to weaken our exchange rates?
Regards
Eddie, Another way to look at it is to say there can only be a trade deficit if someone in the UK (usually Govt but it doesn’t have to be) does finance it. So we can regard the pound as having a ‘natural’ value at which exports and imports balance. But if anyone net borrows then its value will increase and that so that borrowing will create a trade deficit .
The “higher quality products” argument is similar to the popular notion that somehow German people is better at making things that the British. But, since WW2 the common perception in Germany is that a lower currency is better for the German economy than a higher currency. This leads them to be net exporters. On the other hand the common perception in the UK is that the pound should be kept high as a matter of national pestige. The Germans started with a new currency after the war so they were never able to compare what there currency was worth in US$ terms with what it used to be worth in the pre war era.
Of course as the German economy became stronger the currency naturally did appreciate but the German government did everything possible to keep it low. That thinking carried on to when they adopted the euro. Whereas other countries wanted to go in a high level they did everything possible to go in at as a low a level as possible. They now run a 7% trading surplus which causes their trading partners in the EZ no end of trouble.
So is that currency manipulation? Well yes it is. They’ve decided, rightly or wrongly (I would say wrongly) that they want to be net exporters and so have fixed their exchange rate to suit.