Stop rewarding irresponsibility - reform the MPC!

There has been much talk about changing the 50p tax band (on income over £100,000) as a way to aid the economy, but this is in my view a completely artificial distraction from the underlying economic and political issues.

Arguments forwarded that the country needs to stimulate spending to reduce the deficit (on the basis that this will reduce the drain of wealthy consumer-investors to places like Switzerland) understate the risk of more new short-term solutions. Obviously the need exists among both coalition partners to succeed in creating a balanced budget by the time the next general election comes around, but the signal this measure would give to city institutions and the wider economy presents deeper risks.

From back in the mid-1970s when income taxes reached their zenith at 98%, the tendency to liberalise markets has seen a shift in fiscal policy towards indirect taxes on expenditure (ie through VAT) and a corresponding shift in employment from manufacturing towards retail services (including high street banking). And whenever government commitments overextended the consumer dollar was increasingly seen as a bottomless pit, the destination of first resort for the Treasury to squeeze by stimulating spending another notch.

Yet the banking and financial crashes of recent years indicate a tipping point has been reached as high levels of personal debt coupled with low levels of personal savings mean the public is almost squeezed dry.

I mean, how much worthless tat could you fill your Christmas stocking with anyway? How much turkey can you fill your obese belly with? Break all your toys before dinner time? Collapse in an intoxicated stupor over the toilet bowl after? Who cares, just enjoy the holidays!

Interest rates of 0.5% mean saving responsibly has been disincentivised in favour of borrowing up to and beyond the capacity to repay. Successive governments have virtually wiped out pensions and prudential investments by abusing inflation as valid economic tool in favour of the casino capitalism of risk creation, and now exceptional policies such as winter fuel payments are vital extra assistance because the money given to the state to pay for a standard retirement has been frittered away by transfering wealth to people demanding they have it all today. And let's not forget the policy challenge to public health and education systems funded by debt.

Economists are widely predicting a decade of stagnant growth and high inflation at or above 5% (currently 4.4%) will be required to sort out the current problems, and this has lead some to argue the Bank of England's Monetary Policy Committee has failed, since their primary responsibility is to keep it in the 2-2.5% range.

Back in 1997 it was one of the headline initiatives of the incoming Blairite government to give independence to the BoE on setting rates, justified on the ground that it depoliticised one of the primary policy tools available to government where the previous regime had patently failed by getting things spectacularly wrong during the ERM fiasco (raising rates from 10% to 15% in a single day to support the currency, thereby causing mass unrest in the housing market as 'negative equity' became a byword for political irresponsibility).

It had been a LibDem idea, and Labour's Gordon Brown over at No11 was sufficiently suspicious of it to use a succession of methods to maintain the control he'd publicly disavowed. Primary among these was the system of appointments to the board which ensured the political balance was favourable to the party in power (economists such as David Blanchflower - an MPC member from 2006-9 - could and can still be relied upon to defend the political aims of Labour), thereby exposing the lie and highlighting the effective non-independence of the MPC.

I was originally enthusiastic, but I've since grown critical of the naivety of thinking that economists are able to think independently of political motivations - indeed the more I learn the more I realise they are often among the most political people around. Since they've immersed themselves in a career of calculating research data to provide supporting evidence for the positions they assume economists uniformly tend to be the least open to logical argument, and they are psychologically incapable of denying themslves because of their doctrinaire adherence to whichever school of thought they were raised within or currently subscribe to. They irrationally avert attention from the role of their agency within the social forum of debate: economists are epistemological-empirical totalitarians.

In fact when we look at MPC predictions for inflation they consistently show two things, that all predictions for the future will bring inflation on target within two-to-three years, and that all previous predictions in the past have been wrong by increasing factors. In other words their decisions have increased inflationary volatility where their task was to do the exact opposite.

Returning to the tax issue, it strikes me as particularly odd that the coalition government (who's stated intention to rebalance the economy by encouraging export-led manufacturing) should be open to spending stimulus, even though more quantative easing was rejected by the MPC. It suggests either there is a budgetary problem on the timing of plans to eliminate the deficit, or that tories want some ideological meat to fill their conference boots, or both.

So it's understandable that the punative symbolism of the 50p rate has become a bone of contention as different sides each argue to optimise Treasury income at a maximal level, provide a boost to the wider economy and develop greater fairness in society.

But the politics of the 50p rate are a complete distraction.

As others before me have mentioned it is possible to keep a 50p rate by raising the level at which it is levied (eg from £100,000 to £1m), it is possible to increase fairness by raising the levels of personal allowances (the zero-rate) to £10,000 or higher and the level at which the basic and other rates are levied, just as it is more than within the scope of possibility to introduce intermediate 25p, 35p and 45p rates to improve Treasure balances. And there's absolutely no problem with doing all these at the same time - in fact differential impacts would be minimised by implenting all simultaneously as that would provide greater potential for flexibility. Alternatively it is also possible to do nothing about it and use a variety of indirect tools instead.

I've argued that resistance to raising the levels at which tax bands are levied to keep up with wage inflation since market liberalisation began at the end of the 1970's (tentatively under Callaghan, wholesale under Thatcher) coupled with exponential wage growth towards the top of the scale has been an effective 'double-whammy' for those towards the bottom of the society - something which has driven growth in economic inequality despite government efforts to compensate. Arguably the compensation methods themself have been counter-productive since they add complexity to the system and are therefore less cost-effective, driving the polarised tax policies of left and right which in turn requires greater efforts to reduce inequality - and the diminishing returns of successive policies increase the inevitability of confrontation with reality.

So the two-party system creates a vicious circle of political swings and roundabouts!

And efforts to reduce the deficit and restore some sanity now revolve round the issue of growth.

The range of policy options open to the Chancellor are limited. On monetary policy the Exchequer no longer directly controls interest rates, but they are at rock bottom and can't be reduced further anyway. Similarly, quantative easing has been rejected by the MPC because inflation is well above target. On fiscal policy personal debt levels mean VAT cuts would cost too much and would create additional risk of instability if wages remain depressed compared to inflation. So that leaves targetted income tax cuts with all their associated political baggage.

And this creates a massive quandry for policy-makers. Internationally the problems are virtually identical, yet Obama's desperate speech to the joint house session announcing wide-ranging measures leaving few options unexplored was in stark contrast with Berlusconi's declaration of political impotence. Both fear what unpopularity would mean for their chances of reelection, but where the US President worries about the consequence of inaction on his ratings the Italian Prime Minister sought to preemtively excuse any action whatsoever.

My solution in the UK would be to reverse my earlier position towards the MPC. While I support the concept of independence for the MPC and the effect of greater interest rate stability they have produced, they are neither fully independent nor accountable and this has resulted in them lowering interest rates too far. So I would make a one-off intervention to set rates at 2% and then set about reforming the way the MPC is constituted.

Oddly, my conclusion abut how to reform the MPC is inspired by the failure that lead to its creation.

The Exchange Rate Mechanism ran from 1979 when Sterling uncoupled from the Irish pound and a system of bilateral measures were introduced between European currencies to keep fluctuations within a 2.25% margin, thereby preparing the way for integration into a single European currency.

After having initially appreciated, Sterling then gradually fell back as trade between the participating nations grew during the 1980s, and the UK joined the ERM in 1990. By joining the party late in the day currency speculators were sceptical about the motivations of the then-tory government under Thatcher. So when prominent right-wingers including Norman Tebbit complained about spending billions to support the currency and prevent deepening of the recession speculators such as George Soros felt this confirmed the lack of commitment to the political cause of European integration and that Thatcher never intended to replace Sterling with the Euro (it's an ironic fact that Tebbit was considered an arch-proponent of Thatcherite ideology, yet his ill-considered words in her defence were the primary cause of her downfall).

Black Wednesday occurred because the Bank of England reversed it's policy to intervene in currency markets as the means to support Sterling when foreign currency reserves fell below safe levels and decided instead to take the desperate measure to use interest rates. The incident 'broke the Bank of England' and forced Thatcher from office because it showed the selfish self-interest of her and her cabinet in a way that previous campaigns hadn't (privatisation and the sale of council houses was defended as her democratising tendency, while her battles with trade unions was presented as ending harmful restrictive practises). John Major couldn't repair the damage and the separation of monetary and fiscal policy followed.

The margins of the ERM were expanded to 15% in 1993 when currency speculators began moving against the Franc, and when the Euro was introduced in 1998 the mechanism was replaced by a new system where non-members were required to stay within that range for two years before becoming eligible for entry to the Eurozone. So we can see that provided the level of variability is controlled within an acceptable level this does increase harmony and allow for greater integration.

However the jump from 15% variability to full membership within 24 months has allowed countries such as Greece to join the Eurozone single currency area and this hasn't been sufficiently strong to encourage internal reforms to develop fiscal sustainability, and the riots over current austerity plans are a direct result. Greece was not ready before joining and the lack of a physical border reduced trade benefits after joining, meaning membership was more a matter of political prestige for the nation than economic reality. Whether Greece can now retain her membership of the Euro hangs in the balance. Whether it's desirable is a matter of opinion. But when any changes occur will indicate the manner and form of union Europe will eventually take - leaving may set a precendent, while staying within the Eurozone will require a more direct form of centralised budget planning.

In hindsight a progressive reduction in variability would have provided greater motivation for reform and a better timescale for membership. How this relates to the UK picture on interest rates is in the tension that arises between centralision and decentralision.

A major part of the economic problem in Britain is precisely the same as in the Eurozone: divergent trends around different regions - what's good for the City is usually bad for the towns and shires; what's good for industry-led regions is not for service-led localities. So how is it possible to reconcile the effects of interest rates in the vibrant commuter stockbroker belts and the blighted urban cores and rural outposts where deindustrialisation has wrecked its effect? Can mega shopping malls effectively replace factories? Clearly some policy flexibility is necessary.

The principle of variability has already been adopted through the process of political devolution created for Scotland, Wales and Northern Ireland by allowing for some revenue-raising powers to give a proportionate measure of tax variance (although these have yet to be used by nationalists for fear this would reduce any seperatist sentiment). I'd like to see this principle extended by the establishment of regional offices for the central bank, each with the corresponding competency for setting rates (within appropriate limits) and the establishment of regional bond markets (with proportionate volumes) - an Interest Rate Mechanism, for want of a better name.

It's always struck me as weird that interest rates are measured in quarters, but I think this gives ample means to allow the centralised national bank to coordinate decentralised regional offices within natural fractions. If the BoE is given additional flexibility to vary the central rate by tenths, then it's a simple matter to allow regional offices to vary this by up to one-tenth (ie by hundredths) - and, most importantly, the preponderance of the regional offices will provide a true indication of the correct direction for any national variation (ie if the vast majority of regional offices vary from the central rate in one direction, then this is incontravertible evidence in itself that the central bank should move the central rate in this direction, and equally by what amount).

The creation of such a competitive market therefore removes any ability to politicise the issues from the centre. It would reduce the abilty to obscure the political issues dividing debate. And it would provide meaningful independence within a coherent and stable structure - which can only be a healthy thing.

Obviously this would also reinvigorate the case for regional assemblies to provide political accountability for the spending of revenues in the interest of their regional economies, which carries it's own risks, but by doing so it would also reinvigorate political participation and remove the pressure on local government caused by the distribution by ministers of fixed formula grants - local people would be able to take responsibility for ourselves!

In an already over-stimulated land full of under-appreciated people struggling in a depressed economy, the last thing anyone wants or needs is fresh stimulation. What's needed is a bit of rehab.



Finally it's worth mentioning the corresponding effect on fiscal policy which would be caused by changes to monetary policy decision-making processes.

Simply by reversing the dynamic of monetary policy to be responsive to demands, rather than as a lever to control demand, it would simultaneously reduce the pressure on politicians to use tax policy as moral compensation for social inequality, thereby gradually reducing the overall tax burden by eliminating the artificial demands created by partisan lobbyists for the political choices (or failure, as they see it) of their opponents - which would in turn encourage less wasteful use of taxpayer's money.

Correspondingly, the reduction in the overall tax bill provides less incentive to company directors able to transfer their wealth between tax regimes and use other legal tax avoidance measures. Surely it is completely unacceptable and utterly perverse for anyone to simultaneously set both the level of their own income and the level of tax they pay on it, let alone for a small minority of super-rich to abdicate responsibility to their employees for the state of the country they live and operate in!

And here it worth drawing a link between criticism of the irresponsibility of the anti-social anonymous underclasses towards their communities and the irresponsiblility of the anti-economic celebrity overclasses towards their neighbours - there is a poetic symmetry in the reflection of one with the other, and the only way to resolve their opposing attacks on the general mass of ordinary people is for government to set an example by acknowledging its' own failures, and reform.

Reform thyself MPC!