My Lords, I am grateful to the noble Lord, Lord Desai, for reiterating government policy. Like other speakers, I am grateful that prime time has been given to the House to discuss the current economic situation. As I am nearly in the graveyard slot, I am quite surprised that I have got one or two original ideas still to add to the debate.
First, as a former UK fund manager, I also welcome the noble Lord, Lord Myners, to the Government Front Bench. I was able to benefit from Gartmore's expertise for my clients, through its Far East and Irish funds in particular, and its performance contributed to the high regard that was held for him and Gartmore in the City when he was at the helm. His expertise will add enormously to our deliberations here. However, if he had been making a current fund manager presentation I think he would have offered a more balanced view of the UK economic situation.
I should first like to make a few comments on the Government's stewardship of the economy since 1997. I then wish to iterate my view of the key causes of the current economic crisis, discussing the global and UK background, before coming up later in my speech with a slightly more original look at the possible solutions. I always give the Government credit for their key decision to hand over control of interest rates to the Monetary Policy Committee in 1997. I also have given them credit for keeping inflation in line with the MPC's target for part of the period after that. However, after their decision to stick to Conservative spending plans early on, I have been cautious about the effectiveness of the spending on health and education in particular, especially as the Budget deficit kept increasing.
Continued growth made for overconfidence. As many speakers have pointed out, the Prime Minister claimed in March 2007 that he had abolished boom and bust. The serious argument that he was trying to make is that the situation we are in is at variance with the economic cycles of the 1980s and early 1990s—in other words, he was saying that the boom and bust we are in is not the old boom and bust. The trouble is, we have a new boom and bust. The old boom and bust featured rapid fluctuations, with a medium-sized boom followed by a medium-sized bust. This time we have had a long period of growth followed by a bust so bad that it has nearly destroyed the financial system. The stability was a trick of the light; the lengthy period of growth was fuelled by house prices and debt. The length of the good years has been paid for by the severity of the crisis we now face, yet still the Government do not seem to have learnt certain lessons.
The Chancellor wants to return to 2007 levels of debt. That cannot be a good idea. To see why requires analysing the causes of the economic crisis. As many noble Lords have stated, the crisis has been caused globally by debt reaching unsustainable levels and by investors looking for higher yields in a lower interest rate environment without considering the risk. It began in the USA and has spread faster and more broadly than many of us would have predicted. In the UK it has differed crucially from the two previous economic crises, which were caused by high interest rates and high inflation. This is a balance-sheet recession, where inflation and interest rates have been low, low interest rates encouraged individuals to borrow more and buy property as it seemed to be going up in value for ever and ever, and financial institutions were prepared to lend on an increasingly reckless basis to finance the borrowings. In the USA this recklessness was emphasised by lending to so-called NINJA borrowers—no income, job or assets. In the UK, financial institutions were lending 120 per cent of the value of property.
The UK has been particularly badly affected by the crisis because our economy, as many speakers have said, is dependent on financial services and the Government have gone on a borrowing spree. The level of borrowing has reached the top limit of its self-imposed financial rules, thus allowing no room for pre-emptive pump priming to stave off trouble. Nothing had been kept back for a rainy day. The USA and UK crises have had two key components: a crisis in the financial system and a crisis among households where personal debt has been high. The crisis in the financial system has not only been one of debt but a crisis of confidence in financial institutions lending to each other. It is easy to forget that the hugely successful investment banks were up to 30 or 40 times geared, so they were able to finance deals that now would never get off the ground. This is another example of, with hindsight, the overuse of borrowing. Debt got to an unsustainable level, and any sustained fall in the housing market was likely to lead to a crisis.
A crisis in the financial system can always be bailed out by Governments, which is what has happened in this case. I give credit to the Prime Minister for his handling of this crisis, but we must not forget his Government's responsibility for it. Household debt is a separate issue. People try to rebuild their savings, which is very difficult. They cannot borrow any more money because the banks themselves are stretched, and the value of their housing has gone down. As personal income is not rising and people are trying to save, consumer spending falls off a cliff.
How do Governments sort out the household problem? Mine is an amateur economist's solution, and may cause surprise. I have been cautious about the rise of inflation until recently, but now I believe it has peaked. In particular, sharply declining commodity prices and weakening demand will help, along with the slowing down of wages as job losses unfortunately hit the real economy. Like the noble Lord, Lord Bilimoria, I believe that in these exceptional circumstances, for a period, the Bank of England should relax its inflation target and allow it to remain at the current level so that the real value of debt will decline over a period. Thus I would support the Bill of my noble friend Lord Saatchi.
In terms of UK fiscal policy I would, however, criticise the idea of big increases in government spending. Last week, the Chancellor of the Exchequer conceded that he would have to abandon the fiscal rules. Michael Saunders, an economist at Citigroup, said that the UK now has no credible fiscal rules. Without such rules, as the noble Lord, Lord Skidelsky, remarked, confidence will weaken and the cost of Government borrowing will rise in addition to its level increasing. At the end of the day, the cost of this will fall upon the taxpayer, even if he is given short-term government support.
Here I would like to promote the Ricardian equivalence theory. Consumers will not increase spending if Government increase their deficits because they know that although they may have more money now, they will have to pay higher taxes later, so the extra saving by consumers would offset the extra spending by Government.
The major economic action, as many other speakers have said, should be taken on monetary policy. I have until now fully supported the MPC's concern about inflation, but now that the threat is passed, it is time to lower rates, and lower them quickly. They should be pushed down to 1.5 per cent to 2 per cent. That will help weaken the pound further, which will aid our exports. That will, I hope, help boost the money supply, which has weakened due to the removal of the prop of support from hedge funds and the derivatives markets and the banks' crises of confidence. It is becoming common knowledge that even good companies are finding it much more expensive to renew bank facilities. Weaker businesses are finding it harder to borrow at all.
Also putting pressure on companies and businesses are increasing pension fund deficits caused by the collapse in stock markets. Actuaries are insisting that contributions are increased. Profits, therefore, will be under further pressure; one route, sadly, to remedy this is job redundancies, which are likely to rise for these and for demand reasons. Therefore, interest rate reductions are crucial but even then they may not be enough to improve confidence in the short term of the real economy, which is likely to be weak for several years.
I turn finally to regulation, on which I think I have something original to say. The incorrect knee-jerk reaction to the financial crisis will be to overregulate. Unlike what the noble Lord, Lord McIntosh of Haringey, said, what is needed is better quality regulation rather than quantity. Regulators need to be better trained and more experienced. They have to be fully up to the mark in the area of derivatives. They should tighten up on off-balance-sheet finances. UK regulators are very good at prosecuting minor offenders while the major culprits get off scot free. The UK needs to take a leaf out of the US SEC's book in bringing financial wrongdoers to justice.
Overall, the tripartite regime introduced by new Labour has clearly not worked. More power needs to be given back to the Bank of England to monitor financial institutions' solvency.
In conclusion, the Prime Minister deserves credit for his action on the financial crisis, but it must not be forgotten that he must take a lot of responsibility for allowing it to happen.