Smash hit

We can debate until the cows come home how what I think is a more modest overvaluation is worked off. House prices are down on a year ago and incomes are rising, so that process is under way. But what effect does the end of the house-price boom have on the wider economy? Blanchflower was clear. “I think it’s plausible that falling house prices will lead to a sharp drop in consumer spending growth,” he said.

Contrast that with a speech by Charlie Bean, the Bank’s chief economist, just last month.

“Some commentators look at the historically strong correlation between house-price inflation and consumption growth and conclude that if house prices fell significantly, then that would also generate a sharp slowing in consumer spending,” he said. “But it is not clear that this need be so.”

In the end, the direction of causation may be less important than the result. In the early 1990s the housing market and consumer spending fell, the latter driving the economy into recession, because both responded to a sharp tightening of monetary policy — a doubling of interest rates — in the late 1980s. It became self-feeding when unemployment rose and people realised the annual rises in cash income they had been used to in the more inflationary 1980s would not continue in the 1990s.

This time it is not the price of credit that is the problem but its availability, which is affecting housing and, if left unchecked, will hit consumers and businesses. In another stunning bit of news a few weeks ago, the Bank announced its £50 billion liquidity scheme for the banks. The quid pro quo for that should be that the banks move out of their overkill phase in reining back lending and return to something more normal. If not, the effort will have been wasted.

PS: Just as there is disagreement on the MPC, so there is on its shadow, which meets under the auspices of the Institute of Economic Affairs. It votes 5-4 to hold Bank rate this week. There are a couple of “Blanchflowers”; both Roger Bootle and Patrick Minford favour a half-point reduction to 4.5% this month. There were also two trimmers, with Kent Matthews and Philip Booth arguing for a quarter-point cut.

The five who voted to hold had different motivations. Gordon Pepper said the Bank’s £50 billion liquidity scheme had lessened the need for immediate action on rates. Andrew Lilico said the Bank would lose credibility by cutting when monetary policy was ineffective, so it should keep its powder dry.

Anne Sibert and my near namesake David B Smith were concerned about uncomfortably high inflation. Trevor Williams of Lloyds TSB said the Bank should concentrate on restoring liquidity, not cutting interest rates.

So there is a debate to be had. The Shadow MPC’s minutes are on economicsuk.com , the Bank’s on bankofengland.co.uk . What should happen? I would cut by a quarter this week, if only to lower the bar for money-market interest rates. While not agreeing with everything Blanchflower said, risks to growth are greater than to inflation. The Bank’s last inflation report predicted a big bounce in growth in 2009, which is now looking less likely.

Commodity markets are fickle and should not dictate UK interest-rate policy. Gold has fallen 17% in the past few weeks. Will rates be cut? That’s harder. King’s comments last week suggested not, and two Bank “hawks” — Tim Besley and Andrew Sentance — voted against April’s reduction. The markets think there will be no change. But it will be close.

david.smith@sunday-times.co.uk

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