The pound must fall to avoid a ‘lost decade’ for the UK economy

Civitas, 30 April 2013

By David Green, director of Civitas

Today we have published An Exchange Rate Target: Why we need one, by John Mills. It argues that the value of the pound should fall. Demand for the pound has been kept artificially high because we have been selling off our businesses and high-end residential properties to overseas owners and selling government bonds to non-UK residents.

This extra demand for our currency has tipped the balance against our manufacturers, despite the massive and sustained improvements in productivity they have achieved in recent years. Our long-standing trade deficit means that we are fully entitled to adopt policies that push down the value of the pound until we have a trade balance.

The pound has benefited from a weaker exchange rate since 2008, but it has not led to a large increase in exports because manufacturers have been reluctant to invest in new capacity for fear that the pound will strengthen before they recover their costs. To give exporters the confidence to build new capacity, the Government should declare that it intends to try to keep the pound within a specified range. Even if market pressures make the target difficult to achieve, the very fact that the Government is attempting to maintain stability will reassure investors.

Influencing the exchange rate does not necessarily imply printing money, which would be profoundly harmful if it led to hyper-inflation. Numerous countries (Norway for example) that earn income in dollars, keep their earnings in dollars by buying US assets. This prevents their trading success from pushing up their exchange rate.

The exchange rate is a price, and prices drive markets. It is a price that is unavoidably influenced by the policies of various governments. China has by common consent been manipulating its exchange rate. In the 1980s America became concerned about its balance of payments because of the low-price of the Japanese yen. It led to the Plaza Accord of 1985, after which the yen sharply  increased in value against the dollar. Without the exchange-rate advantage, Japan was not as successful as it had previously been, and arguably the adjustment led to its “lost decade”.  If we wish to avoid our own “lost decade” we need to ensure that our exchange rate is at a rate that will help to reduce our trade deficit.

You can read An Exchange Rate Target: Why we need one here. To read more of our work on the economy, including books, research papers and the Ideas for Economic Growth series, visit our website here.