correlation coefficient

Olivier Blanchard, chief economist of the International Monetary Fund, has egg on his face. He attacked George Osborne, the UK chancellor of the exchequer, for seeking to reduce the UK’s fiscal deficit too rapidly, claiming that it would prolong recession. Mr Blanchard has had to admit that he was wrong but his admission has been reluctant and ungracious. (This is the same mistake that cost former UK culture secretary Maria Miller her seat in the cabinet this month.) 

I argued in my previous blog that sterling is overvalued. Objections to this usually take one of two forms. The first is to argue that UK exports are uncompetitive, not because of the exchange rate, but because of the general failing of UK manufacturers: they do not invest enough in research and design, are insufficiently aggressive in seeking out new markets or otherwise incompetent. All of this may or may not be true but strikes me as beside the point. They are what they are. Government exhortations to improve their behaviour seem unlikely to be fruitful and far less effective than a fall in the real exchange rate. This would not only make UK exports more competitive, but would raise the profitability of exports and encourage both capital and competent management to move into the sector.

The second objection is to claim that sterling has been weak and that the failure of this weakness to improve exports shows that the exchange rate is not to blame.

The problem with this argument is that, by selecting different starting points, sterling can be shown either to have fallen or to have risen. For example, by April 7 this year sterling has risen by 58 per cent against the US dollar since February 26 1985 and fallen by 18 per cent since July 31 2007.