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If the hon. Gentleman has studied recent economic history, he will know that generally the savings ratio declines as inflation falls. That being so, there is nothing unusual in the present economic cycle. I am pleased that the hon. Gentleman acknowledges that the Government are doing well on inflation. We are meeting the declared 2.5 per cent. target that the Bank is steering towards, and if we take the standardised or harmonised index of inflation that is used across Europe, we have the lowest inflation rate in the European Union.
That is no accident. It is happened because of the measures that the Government have taken. Granting the Bank of England operational independence on the management of monetary policy made a direct contribution towards the success with inflation, as has the principle of using inflation targeting. The sound fiscal stance that the Government have taken has also contributed directly to our impressive inflation record.
The interesting question is whether through the medium and longer term we can hold our excellent track record on inflation. The chances of doing so are good.
We are at a point in the economic cycle when traditionally the Bank of England has started to have inflation worries. We have had several years of steady growth in the economy, and we can look forward to more ahead, as my right hon. Friend the Chancellor promised today. Historically, at this point in the cycle, there has been much anxiety about inflation prospects. By contrast, inflation pressures at present are pretty subdued, and there are many fewer such pressures in the economy than at this stage in earlier economic cycles.
There are plenty of promising signs for the economy. The money markets believe that we are on track to maintain, and to deliver, continued low inflation rates. Our long-term interest rates are lower than in the United States. Inflation expectations are well down across the board. We are seeing the fruits of better and stronger competition in the economy. That is another structural change that is helping to keep inflation down. There is also improved price transparency. That is important, given that 50 per cent. of our gross domestic product is traded.
Wage growth at this point in the economic cycle is also quite moderate. The Monetary Policy Committee and the Governor of the Bank of England have expressed some concern at wage settlements, and in recent months the total earnings figures have been edging up. They have gone above 5 per cent., and I know that the Governor of the Bank of England has sounded some alarm signals.
However, beneath the top figure that I have quoted is the settlement figure, which tells a more interesting story. The settlement figure has held pretty steady at around 3.5 per cent.—precisely the sum that one obtains when one adds inflation to productivity growth. That suggests that the underlying rate of wage growth in the economy is perfectly consistent with keeping to the inflation target. Again, that is unusual for this point in the economic cycle and it represents something of a breakthrough in terms of controlling inflation.
There is evidence to show that many of the fundamental relationships in the economy are changing. The Bank of England and the Monetary Policy Committee need to study the changes carefully, as it is likely that the monetary policy rule book is in the process of being rewritten.
The Government have a part to play in underpinning the progress that has been made. That would all be lost if we were ever to return to management of the economy based on boom and bust, or if we were about to embark on a tax-cutting spree—as happened in the late 1980s, when the Conservative Treasury had reasonably full coffers. It is essential to hold fast to the golden rule introduced by my right hon. Friend the Chancellor. I was pleased that today's Budget statement makes it clear that he is doing just that. He is locking in the fiscal surpluses, and he is forecasting Budget surpluses for each of the next four years.
It is also important that we hold to our achievement in reducing the ratio of public debt to GDP. The Government inherited a ratio of 44 per cent. on assuming office, and my right hon. Friend the Chancellor announced today that that will fall to 33 per cent. in the medium term. The combination of the golden rule and delivery on the ratio between public debt and GDP represent a substantial breakthrough and show that the Government's prudence has contributed to the strong record on inflation.
In the run-up to the Budget, many commentators and analysts urged fiscal tightening, as they were worried that the Budget would cause interest rates to rise. In fact, fiscal policy has been tight for some time—rightly, given the strength of the economy. Over the past four years—so before any of the measures announced today—fiscal tightening was equivalent to 5 per cent. of GDP. It was 0.9 per cent. in the past financial year alone. My right hon. Friend the Chancellor has ensured that that is all locked in, and he is right to have done so, as it will help us to continue to deliver comparatively low interest rates.
It is worth underlining the benefits that have accrued from granting the Bank of England operational independence. Since that independence was granted, to control the cycle of the economy, interest rates have had to move in a band of 225 basis points—between a low of 5 per cent. and a high of 7.25 per cent. That compares with an interest rate band of 1,025 basis points in the previous Parliament, under the different system. We are therefore able to control cycles in the economy with a far narrower movement in interests rates than previously. That is what we mean by economic stability, and it is good for business. It is much easier for businesses to operate when the movements of interest rates are so much smaller.
The Budget holds to the prudent fiscal line, while providing targeted tax cuts and increases in public spending. The hon. Member for West Worcestershire (Sir M. Spicer), who unfortunately is no longer in the Chamber, was wrong when he spoke of an explosion in public expenditure that was out of control. His speech told us more about his personal view of public spending, which is not one that I share. The truth is that public spending is projected to grow at 2.5 per cent. in real terms per annum.
That is exactly in line with the trend of growth in the economy. It is one of the results of the economic stability that the Government have brought about, and it enables us to lock in the growth in real-terms public spending as well as the fiscal surpluses without any risk to inflation. I therefore urge the Monetary Policy Committee to intensify its study of monetary mechanisms. I suspect that we can run the economy on low interest rates without any risk to inflation. However, I agree that no risks should be taken with inflation.
The progress that I have described helps us to tackle the other two structural problems in the economy that I mentioned earlier—under-investment and low productivity.
Under-investment has plagued the British economy for far too long. We have had a relatively low rate of capital formation, and there has been far too much short-termism in the economy. The boom/bust management of previous Governments has infected the whole of industry, so a stable macro-economic framework is essential for driving investment up and for overcoming our historical problems.
The Government have already done much to help. They have lowered corporation tax rates, and their support for research and development has been supplemented by £150 million in the Budget today. There have been changes to capital allowances, and capital gains tax on five-year investments has been cut to just 10 per cent. Corporate venturing has been supported in previous Budgets as well as in today's, as has the extension of share ownership schemes. In addition, my right hon. Friend the Chancellor today announced the lowest rates of capital gains tax and lower corporation tax.
The Chancellor also announced 100 per cent. capital allowances for IT investment. That very important measure will be widely welcomed by small businesses, of which Britain now has 100,000 more than in 1997. That reflects the fact that taxes for small businesses have been cut by 25 per cent. since then.
The measures that we take are designed to deliver increased levels of investment, and the evidence is that we are making progress. Business investment is up 16.5 per cent. in real terms since 1997. Investment now represents 14 per cent. of gross domestic product, compared with an historical average of just 10 per cent. Inward investment to the United Kingdom has risen by 45 per cent. since the election. It now totals £220 billion a year, and Britain is the leading location in the European Union for preferred inward investment.
The strength of sterling is an important issue for manufacturing companies and farmers in my constituency. However, it is important to understand that the problem is not one of sterling strength so much as one of euro weakness. After all, sterling's value against the dollar and the Asian currencies is fairly level. All the strong inward investment in the past three years has taken place in the context of a weak euro and a relatively high pound. The fact is that manufacturing output is rising—it is up by 5 per cent. on the previous year—and manufacturing exports are rising also.