Rebalancing and the Real Exchange Rate

This speech by Ben Broadbent is a good explanation of the economics of how real depreciation is important in the rebalancing of the UK economy.  Essay question: compare and contrast to the adjustment mechanism inside a monetary union.

39 replies on “Rebalancing and the Real Exchange Rate”

a really excellent article this;It confirms my belief in the wisdom and downright common sense of Ben Broadbent

There is no reason why the education system should not educate people taking the leaving cert so they would be able to have a reasonable go at answering Phillip’s question. It really is quite straight forward and a classic example of something that could accurately be described as “not exactly rocket science” but with is not taught to the general public, yet has real importance to their ability to engage in the democracy in which they live.

Would this essay, by any chance, require some detailed consideration of what would be involved in an ‘internal devaluation’?

I fear, however, you will get few takers, even if, pace Grumpy, it should be dominating the public discourse.

What do people reckon about Mervs performance on Sky News ?
The worst depression or at least potentially the worst of all time.
Somethings got to give.

It is becoming increasingly clear that the UK’s policy of printing vast quantities of paper money (aka Quantitative Easing) and debauching the currency has been a total failure. It has produced, not growth, but inflation. I am not being wise after the event in pointing this out. I predicted it on this site in June 2009.

First, take inflation:

the current UK inflation rate is 4.5% , for Ireland it is 1.0%

And this pattern has been repeated annually since the UK began its program of money-printing (aka Quantitative Easing) and currency debauchment in June 2007.

Between June 2007 and August 2011, cumulative UK inflation amounted to a staggering 14.4% – in Ireland, over the same period it amounted to 0.8%. In other words, Ireland has had stable prices for well over 4 years, while the UK has had runaway inflation, which is now causing misery for savers, serious social unrest, and a wave of strikes this autumn, not to mention the numerous riots the UK has had this year.

Next, take growth:

the last 4 quarterly GDP increases in the UK have been:

+0.6%, -0.5%, +0.4%, +0.1%

in other words, just +0.6% growth between Q2 2010 and Q2 2011:

in contrast, for Ireland GDP:

+0.2%, -1.4%, +1.9%, +1.6%

in other words, +2.3% growth between Q2 2010 and Q2 2011:

and for Ireland GNP:

+2.6%, +0.6%, -3.0%, +1.1%

in other words, +1.3% growth between Q2 2010 and Q2 2011:

So, the Irish economy is once again growing faster than the UK economy.

Some on this site argue that there is a trade-off between higher inflation and higher growth. But, what happens when you have higher (much higher) inflation and lower growth. Where’s the trade-off then?

This time last year, every journalist working in the British media, who was capable of staying sober on a trip to Dublin for more than 5 minutes (and that could be as many as half of them), was sent on a freebie across the Irish Sea to report on the ‘collapse’ of the Irish economy and the ‘social disintegration’ and ‘famine-level exodus’ that were supposed to be occurring. Little did they foresee that over the subsequent 12 months, the Irish economy would grow by 2 times as much (on the GNP measure) or by 4 times as much (on the GDP measure) as the UK economy, that the census would report 200k more people than the migration ‘experts’ predicted, and that it would be the UK, and not Ireland, that was destined to erupt in riots, widespread burnings and general lawlessness. And, as if this wasn’t enough, the UK remains in balance-of-payments deficit, while Ireland has moved into an increasing balance-of-payments surplus. So much for rebalancing. While the UK budget deficit isn’t falling any faster at all than Ireland’s, indeed possibly falling less fast.

But, just like a drug addict who finds the first ‘fix’ wearing off and desperately needs another one, in response to the wearing off of the first ‘fix’ of money-printing (aka Quantitative Easing), the UK has announced just this very day that it is going to repeat the dose.

They are going to print £75billion out of thin air. Just like that. WOW! I must make sure to get my whack of it. Why doesn’t everyone think of that? It won’t surprise me if they drop it from helicopters.

The money-printing (aka Quantitative Easing) measures announced in the UK today will not produce UK growth. They will simply produce another surge in inflation, to be followed by another debauchment of the currency.

It is for this reason that I have repeatedly cast aspersions on the intelligence of those in Ireland who have been moving their savings to the UK. ‘Dumb’ is far too polite a word to describe them. For Heaven’s sake, how much clearer can the UK government make its intentions? They are not in any way trying to deceive you. Give them credit for that. They are telling you loud and clear what their intentions are: they are going to print £75 billion new paper money out of thin air and that runaway UK inflation of well over 5% and renewed currency debauchment will quickly follow. And for all this, they are going to ‘reward’ you with 0.5% interest on your savings. Given long enough, your savings in the UK are going to be eroded away to nothing. That’s what money-printing (aka Quantitative Easing) and currency debauchment are all about. Don’t say that I didn’t warn you.

@Paul H

“Would this essay, by any chance, require some detailed consideration of what would be involved in an ‘internal devaluation’?”

No Paul. It appears that even those leaving cert candidates answering that question who were bright enough to become economics lecturers, would fail to spot the fact that there would be granularity in such a devaluation which would subsequently affect the economic prospects for that country – possible to the point of undermining the net effectiveness of the devaluation itself.

Maybe, one day some economist will be insightful enough to do society a service by pointing it out. S’pose we shall just have to wait for it to occur to someone.


The BOE policy has not been a “failure”. The intention is to keep inflation reasonably high to prevent debt deflation in that high debt country. They (particularly Posen) judge that the appropriate role for a CB at present it to win the competition for highest inflation below, say 6%, and softest currency.

There is a difference between wanting a return on your money and wanting a return of your money. People who moved savings to a UK account did so (in my opinion) because they were fearful of losing savings held in Irish banks. By losing I mean either the whole lot is gone the way of the dodo or it becomes worth much less in the post-Euro exit, inflationary world. If you are going to accuse people of being irrational then you have to understand their thinking. It would have been crazy to have moved savings to a UK account hoping for a better return – you are 100% correct about that. Was it crazy to worry about Ireland leaving the euro? That is something we’ll only know when it does or doesn’t happen.

@Johnny Foreigner
If you where afraid that Ireland would leave the Euro,it would have been rational to park your money in Germany or Luxembourg .

Watched Merv live – and even this Dork was shocked by what he had to say.
But it was not just external flows
If I had to pick one final Industrial policey decision that affected the UK long term was the building of only 1 Sizewell B modern PWR reactor and then shutting down the programme making this one of the most expensive mainline PWRs ever made.
This was the official end of Industrial Britain – although it was destroyed for the most part before this time.
Even if they engaged in only a modest programme of building 1 reactor every two years (coming on line in 1995 ,97 ,99….) the UKs base load would now be nuclear & very cheap.
The excuse back then was there was not enough money………………………….go figure ?
Now unfortunetly they do not have enough trained personnel and enginners.
You can’t print them I am afraid.
The Tory / Labour 2 step has been catostrophic – building a army of bankers who know nothing about the physical world.
Shame how a former great industrial country can be laid low by rent seekers who wished to farm global labour arbitrage.
The destruction of the great UK boffin culture by Jenkins & the others that followed post 1960s is one of the greatest long term disasters ever to happen to a single country.
The City of London is some strange outfit.

@ JTO,

Whatever about delinquencies, what’s the delinquency rate in their mortgage market? How many in arrears? Or getting cut off from their electricity supplier?

@Overseas commentator
Or Swiss francs, or gold. But the point remains – all of these, including a sterling account, were perceived to be a safer asset class from the point of view of getting your money back than Irish savings.

@disgruntled observer
Broadbent’s speech makes it clear that the MPC ‘chose’ inflation over unemployment. Were they wrong? Our unemployment rate after 3 years of deflationary policies is 14.3%. In the UK it’s 7.9%.


They (particularly Posen) judge that the appropriate role for a CB at present it to win the competition for highest inflation below, say 6%, and softest currency.

@Johnny Foreigner

Broadbent’s speech makes it clear that the MPC ‘chose’ inflation over unemployment.

JTO again:

I commend you both for your honesty in explaining UK government policy.

You are both totally correct.

Indeed, I have said similar myself here many times.

The question for Ireland is not primarily whether this is a good or bad policy for the UK (a matter of opinion), but, given that it is UK government policy, whether it makes sense for Irish residents to transfer their savings to the UK, there to receive a puny rate of interest, with a high probability that ongoing high UK inflation will result in a further devaluation of sterling. I have said many times that it doesn’t make sense and that I have moved my savings in the opposite direction. The bottom line of my bank balance tells me that I was correct. I think that Grumpy’s and Johnny Foreigner’s excellent posts should be printed on billboards close to banks in Newry and Enniskillen.

Keeping your savings in Ireland is one of those things where you are right till you are wrong. You are making a judgement about the safety of your investment as well as the rate of return. I hope you are right. My gut (and yours) says you are. But plenty of lives have been ruined on gut instincts and when it comes to the future of Ireland within the eurozone… let’s be honest that’s all we’ve got.

Playing with the Reuters interactive bank stress test thingy.

And under a 8% captilisation & 100% Irish haircut BoI & AIB takes a loss of 3.7 & 3.4 respectively while RBS takes a loss of 12 Billion !!!
That can’t be right can it ?
How much Irish debt do these “Pillar Banks” actually own ?
Is the Irish debt crisis a riddle, wrapped in a mystery, inside an enigma ?

Are we being played like before – like when the Irish banks bought Sterling bonds ?
Should we be sending our elected representatives to Hollyrood ?

When Italy takes a 100% haircut Unicredit tops the poll by a wide margin with a 42 billion loss like a normal sov affiliated bank… but the “Irish” banks on the other hand…………..
Please tell me I am wrong please.
We are maybe reducing our consumption / investment unnecessarily to bail out banks that do not hold a huge amount of Irish sov bonds !!!!
Maybe theres a technical glitch but somehow I doubt it.

Although looking at RBS – they are big into the Piigs – the Role of RBS is a strange one is this whole crisis also don’t you think – its exposure is certainly huge.
I know we don’t have a clear chain of command & division of executive control now that nation states are dead but if so who is in command if any ? although RBS is now a ship of state I suppose.
What a mess this incestuous european financial system is in………

@ThE Dork of Cork

I was also rattled by Merv’s interviews. I think he has seen some writing on a wall somewhere (a wall that most don’t even know is there, let alone get access to) and in his own way is setting himself up to be able to say, “I did warn you/told you so”.

I can’t help but feel that with all the focus on Greece and the Eurozone of late, perhaps we’ve taken our eye off the ball elsewhere. As my American cousin likes to say, “keep your eye on the donut, not on the hole.”

Did I say writing on a wall? Perhaps I meant writing on a Wall Street.

Not to forget Chinese walls of course.

One wonders how ugly any upcoming trade war between the US and China may get.

They are certainly squaring up to each other.

@ PR Guy, Dork, etc

The Sky News interview with Mervyn King is here:

I must say, I thought he was very, very good. Laid out the scale of the problem, what they were doing and why, what could be expected as a result of the BoE’s actions, what couldn’t yet be foreseen. I thought he was particularly strong on the [I paraphrase] ‘things have changed in the last three months, so we have changed’.

@ Gavin

Some good old British phlegm on display, but I’d say MK knows the game is up. A sad man. Perhaps I have a simplistic understanding but all I see is that oiur neighbouring economy is about to go wallop once more. That’s what’s changed in the last three months, and thats tthe only reason you would want to do QE with inflation heading smartly north.

Britian may be outside the EZ, but it’s not outside the markets. The 75bn is going to get stuck on the balance sheets of some very nervous banks, or else it will leak off to EM assets in search of return. Profitable/attractive buisness lending opportunities will remain very scarce in Britain. Stagflation beckons, and a traditinonal run on UK assets is on the cards.

As the Dork might put it, the productive and innovative British economy that we once knew has been murdered. By the standards of history, much of the ‘financial innovation’ has been a travesty, and a crime against the British people. The enemy was not, and is not, Johnny Foreigner.

I note the Sky news clip chose to present a 23 year old pizza maker as a representative of the business sector. Goood luck mate, you certainly need it.

I see the FT front page has a link to a story about RBS putting some restrictions on the use of ATM’s. I can’t get behind the paywall from where I’m sitting this morning. Can anyone drop a note here about what those restrictions are?

“Give us the money or we’ll turn off the ATM’s.” That’s always been the biggest gun to the head of governments because no politician wants to see that on his/her watch. It would make queues outside Northern Rock look like people were just waiting to get into a nightclub.

I can’t believe Moody’s has downgraded all those UK banks and not said a jot about the French… it must be really bad in the UK!

@PR Guy

The American and British press (and by extension the Irish) are talking about the French Banks balance sheets as if they were an inscrutable mystery.In fact they published once a month by the regulator and are made public,one can disagree about the diagnostic,but the symptoms are well known.

Et tu, Grumpy,

Of all people, surely you’re not going to go flaky on us. I fully accept your point about granularity, but that it could result possibly in ‘undermining..the net effectiveness of the devaluation’ is a tad extreme. So we’ll just sit there and allow continued gouging of monopoly profits in the sheltered sectors, gloriously inefficient semi-state structures and financing, madcap climate change investments, etc. etc. just because we can’t be sure about the response of those currently enjoying these monopoly profits, benefitting from the inefficiencies and profiting from the madcap investments.

Nobody said it would be easy, but giving up before any genuine assessment is performed of what might be possible is totally defeatist.

I’m afraid that the only conclusion from watching the Mervyn King interview, along with reading this morning’s UK papers, is that inflation in the region of 5-6% is going to persist in the UK more or less indefinitely (although probably with short-term fluctuations about this level). And even that is assuming it doesn’t spiral out of control and reach 10%, as it quite frequently does once it hits the 5-6% level. In these circumstances, anyone buying a UK government bond yielding 2% annual interest is in urgent need of psychiatric examination.

A tad less schadenfreude would be welcome. The Tories are, ever so slowly, beginning to see that much of the private sector is very dependent on public expenditure in terms both of payments for goods and services and of the personal expenditure of public sector employees. The required re-balancing of the British economy is probably going to be more wrenching for much of the private sector than it will be for the public sector.

But how different is Ireland really in terms of private sector dependence on public sector spend?

And Britain going down the swanee wouldn’t be very good news for many of Ireland’s more exposed sectors – despite the pleasure some people seem to derive from evidence of problems in Britain.

Simply put, if in a monetary union and not planning to leave, internal devaluation of wages and increase in productivity is the way to get more competitive and export more.
However reduced wages and prices make the debt burden harder to bear. This is a key difference to being able to devalue your currency. With a soveirgn currency government debt is also reduced at the same percentage as wages and prices.
This is why many people believe Greece will eventually leave the Euro if its debts are not restructured ‘enough’

People with reduced income trying to repay full euro private debts, especially mortages, adds up to hardship. This is the case for the average Joe in Ireland.
If Ireland had its own currency like the U.K. or Sweden, who both devalued their currencies by more than 20%, it could be saving itself and its people hardship. The low interest rates and high inflation in the U.K. is ideal for people with debts to repay. This is the opposite of the point JTO makes about the lunacy of saving with low interest rates and high inflation.

Boone & Johnson today …..

In Europe, the first thing peripheral governments need to do is stop accumulating debt, and quickly. Italian fiscal plans to balance the budget in 2012 look implausible as they assume unrealistic growth. The currently planned Greek debt restructuring and increased taxes will not turn that economy around — nor prevent Greece from accumulating even further debt. Despite all the reported austerity, the Irish government is still running a budget deficit near 12% of GNP in 2011 while nominal GNP actually declined in the first half of 2011.

Message to Kenny & Gilmore: Main priority remains DEBT …


RE your comments on the U.K.

TOTAL FAILURE? Do you understand the concept of inflating away your debt. The U.K despite having a budget deficit close (it not as bad!) to Ireland and a debt/GDP ratio close to Ireland and keeps it AAA rating while Ireland gilt is junk or near junk. The U.K. could raise cash it needs in the great market, but hang on it dosn’t need to it could just PRINT SOMEMORE.

If only the great ECB would have a great QE s***e the problem of greece would go away for another day but the gnomes in Frankfurt seem to know better.


The BOE did not commence QE in June 2007….QE was announced almost two years later in March 2009….Sterling fell by 30% between mid-2007 and end-2008 i.e. BEFORE QE…Inflation rose from sub 2% in mid-2007 to 5.2% in September 2008 – probably due more to the rise in the oil price, to $150 p/b, than currency effect – before falling to 1% in September 2009 (probably due to the collapse in the oil price) – and in early 2010 was back above 3%…I don’t think the BOE would claim that QE worked that quickly and effectively in raising inflation!

I have to say I applaud the way Mervyn King is trying to deal with what he sees as
“This is the most serious financial crisis we’ve seen at least since the 1930s, if not ever”.

The BOE recognises a reality that Europe has deliberately ignored i.e
The Interbank market is finished for years to come. So too are bank bond issues. But in contrast to Europe the BOE are trying to deal with the problem. In addition to providing liquidity, bank holdings of govt debt is being bought up in huge quantities.

Once the latest round of purchases is complete, the UK’s central bank will own around 24 per cent of the outstanding stock of government debt and Sir Mervyn would not rule out another tranche in the future.

Meanwhile Europe has no central bank. Just an equivalent of Madras school students reading from idealogical scripts from caves somewhere in Frankfurt. These Madras adherents would prefer to let Europe implode rather than question the dogma they adhere to. It is time Europeans started to take control of their economies back from these fundamentalists.

I do have one complaint about QE not only as prectised by the BOE but the FED and elsewhere. That is it does little for the general economy. The money printed in merely added to (or replaces) bank liquidity. The cash just sits there.
Better to invest direct in projects with the funds than attempt to shore up zombie banks etc.

This Swedish MP is saying the boom and bust wasn’t so much Irelands fault as the ECB’s and monetary union.

“How do you tighten fiscal policy to make up for more than 100% of GDP in credit-induced spending power in only three years, as occurred in Ireland in 2004-2007 – and in a democracy sporting a fiscal surplus, as Ireland is? To ask politicians in a democracy with big surpluses to raise taxes or cut benefits or public investment by the enormous magnitude needed to stave of disaster strikes is to be out of touch with reality.

Quite simply, the risks for small peripheral countries are inherent in the system created by the European Monetary Union. The main blame should therefore be put on the system’s founders, or those who saw the problems coming but chose not to raise a word of warning.”

@David O’Donnell

The reading material you provided is a bit heavy for me.
I think my figure of 215b came from IMF projections. Other figure I’ve seen quoted vary from 200 to 250 billion.
So I have a simple question…how do you pay back 200+ billion when your growth is officially projected by the CB as .8% for next year? As for projections for 2013 you might as well gaze into your crystal ball.
JP Morgan reckon we will need a 40% haircut. I think that’s fairly reasonable.


Do you understand the concept of ‘inflating away your debt’?

JTO again:

I understand it only too well.

Because the other side of that coin is: ‘inflating away your savings’

That’s why I got mine out of the UK just in time in June 2007, moving them to a low-inflation stable-currency reasonable-interest-rate location. One of the best decisions of my life.

@Michael C

“The BOE did not commence QE in June 2007….QE was announced almost two years later in March 2009….Sterling fell by 30% between mid-2007 and end-2008”

A great deal of that devaluation was anticipatory. We knew the UK could and had a CB shrewd enough to counter the deflationary effects of the credit crunch by weakening sterling. QE was signaled and speculated about for quite a while.


Expectations play a role, but it’s pushing it to suggest QE was anticipated for the best part of two years before it was announced.

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