UK economic policy is sliding into total incoherence.
According to the Times, Darling wants to defend sterling, which has fallen remorselessly since this crisis began. He is going to achieve this by saying that the government "has not abandoned its fiscal policy rules."
Darling can say what he likes, the data tells us that the government abandoned its fiscal rules long ago. Last week, Darly talked about accelerating government expenditure. With tax revenues falling, this is a template for a higher public sector deficit. Besides, the UK government is likely to run up a deficit of at least 4.3 percent of GDP this year.
On the monetary side, the situation is also a mess. Interest rates are about to come down. This will further weaken sterling, and runs counter to Darling's aim of defending the currency. Afterall, there is nothing like reducing the rate of return on sterling assets to lead to a capital outflow.
As for inflation, again there is incoherence. The BoE have already cut rates, which are now negative in real terms. As expected, sterling crashed and inflation increased. Now, the MPC will cut again, which will further weaken sterling.
There is an alternative to this chaos; get the policy fundamentals right. The government needs to restore confidence in the public sector accounts. This means restraining expenditures, and if necessary, increasing tax.
For its part, the MPC should raise rates and ensure that they are positive in real terms. As for the financial crisis, the government should recapitalize them as planned, the FSA should be abolished and supervision returned to the Bank of England.
In the short run, this will generate a recession. This will be painful, but with a stronger, more credible policy framework, based on a sustainable fiscal policy and a credible anti-inflation strategy, the economy will bounce out of this slowdown more quickly.