Osborne’s opportunity to explain his economic thinking

Should Britain be throwing out the bath aswell as the bathwater (if not the plumbing too) of our 13 year-old macroeconomic settlement? It is a worthy question to ask following our calamitous recession, particularly so, ahead of an election.

For a decade or so, nearly all commentators were mesmerised by the self-reinforcing genius of inflation-targeting, Bank of England independence, and those famous fiscal rules.

Well, how about adjusting or even abandoning our current two per cent inflation target and letting a moderately higher level of inflation help smooth along the painful process of deleveraging?

Ridiculous? Heresy?

Well it is almost precisely what Olivier Blanchard, the chief economist of the IMF, floated in a paper published this month by the IMF, which argues why an inflation target of four per cent could be superior than a two per cent target. Put simply, an inflation target of four per cent minimises the risk of deflation and the need for near-zero interest rates. 

Of course, it is also the first step towards uncontrollable inflationary spirals, rack and ruin, and using a £10,000,000 note to buy your copy of The Economist. That such a policy is being contemplated at the IMF, will also mean that it’s being chewed over at the Bank of England and the Treasury.

Of course, there is no incentive to admit it, because markets will react to any perceived weakening in the Bank’s anti-inflationary resolve. Though it’s worth noting, under the terms of the 1998 Bank of England Act, that the annual setting of the target is made by the government.

So do any of Messrs Darling, Osborne or Cable take Professor Blanchard’s idea seriously?

Well we have an important moment for George Osborne tomorrow. He is giving the prestigious Mais lecture at City University. It’s a lecture where in 1981 Geoffrey Howe launched ‘the Fight against Inflation’ with a background of inflation in double figures.

And then in 1984 Nigel Lawson marked a change of direction, emphasising the centrality of monetary policy in managing demand. Blair and Brown also gave high profile lectures.

In recent weeks, George Osborne and David Cameron have been talking about getting Mervyn King involved in tax and spending policy, and I mentioned the other day why in these strange economic times it might be a good idea
Mervyn King said that he ‘didn’t understand the proposal’.

But this morning, at the Treasury Select Committee, King made this reference to the possibility of inflation remaining high. ‘There are risks there could be further upward movements [in inflation], whether it be commodity prices or other changes in indirect taxes, who knows?’, he said.

So unwitingly Mervyn King seemed to be accepting the invitation to get involved in fiscal policy, with a clear hint around expectations of a further rise in VAT.

VAT at 20 per cent is the whisper in Whitehall and in industry. It would raise £12bn per year, and industrialists argue that it would also help in the ‘grand rebalancing’ of the UK economy away from debt-fuelled consumption towards investment.

Now I’m not expecting a VAT or inflation target change at the Mais lecture from Osborne tomorrow (though Labour is basing at least part of its election strategy on the Conservative history of raising VAT), but the shadow Chancellor will have to put some flesh on policy bones.