Economic benefits of a slide in sterling

The Shadow Chancellor is accused of encouraging a run on the pound. Sterling slips below Euro 1.20 and some commentators forecast parity between the pound and the Euro before too long. And sterling is now trading below £1.50 for the first time since 2001.

Exchange rate weakness is nothing new for the UK economy. I remember well as an undergraduate at Cambridge in 1985 the day when the pound tipped precariously towards parity against the US dollar. The external value of a nation’s currency should not be regarded as some kind of national virility symbol and deliberate manipulation of a currency through intervention or interest rate changes is rarely effective.

Foreign exchange markets are powerful forces in engineering much needed changes in price and cost competitiveness and the UK government and the Bank of England should not seek to prevent the pound falling to a level which provides an essential rebalancing of the economy away from domestic consumption and a trade deficit and instead towards higher personal saving and a current account surplus.

Despite the risks of an over-shooting of the pound in a downwards direction, the exchange rate adjustment we are seeing at the moment is a crucial part of macroeconomic demand management. Having a floating exchange rate is the UK economy’s flexible friend and having the option available to us is an important reason for the UK to remain outside of the single currency area.

In his typically forthright style, Martin Wolf writes in the Financial Times about this issue.

“The fall in the pound is not the problem; it is the solution…..the UK must ultimately save more and the current account must go into surplus. If these are to be achieved, a big real depreciation of the exchange rate must occur. This can be secured either by a long period of falling nominal wages and prices of non-tradeable goods and services or by a fall in sterling. Fortunately, the latter has delivered what is needed.”

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