The Pound in Free-Fall

There has been a bit of excitement in the last few days over the fall in the value of sterling. Here is The Sunday Times going over the top in a "news" story:

Experts warn there could be a major slide in sterling with the pound heading to parity with the euro for the first time since the financial crash of 2008-09.

Plenty of others have commented on the benefits of a lower pound, but my thoughts turned elsewhere. What is a reasonable value for the pound against the euro? Britain has experienced higher inflation than the eurozone in recent years and so you would expect the value of sterling to fall relative to the euro.

The OECD produces some figures on purchasing power parity (PPP), which compares the values of currencies in terms of what they can buy. This gives a quick was to estimate the fair value of the exchange rate (at least for the recent past). I have worked the figures to put them on a chart.


Source: OECD, author's calculation

So back in 2005 the PPP rate was 1.32 € per £. This fell rapidly to 1.15 in 2009 and has been at 1.13 € per £ since 2011.

A quick check of the FT shows the market rate is now 1.1655 € per £. So the current market value is probably sightly above the fair value, especially as inflation has continued to be higher in the UK than in the eurozone. The recent slide has in fact brought the market rate closer to reality.

Update: I could do the same for the pound against the dollar. The OECD figures suggests an PPP exchange rate around 1.47 $ per £ in 2011 and 2012. At the bottom of the recent slide the market rate remained above 1.50 $ per £.

Pay Paradox

David Smith in the Economic Outlook column of the Sunday Times (£) asks:

Public sector pay has risen nearly twice as fast as in the private sector in this supposed time of cuts. How can that be?

Despite the freeze on public sector pay average pay has risen from £448 to £491 since April 2009, while the private sector average has gone from £446 to £469, a rise of 9.6% compared with 5.2%. How come? David Smith looks for the answer in flexibility and unionisation, but misses the obvious cause of this statistical puzzle.

The number of employees in the public sector has fallen by 648,000 (including the 198,000 college staff now counted as private sector). The private sector has added 1 million jobs.

The strong growth in private sector employment in the past three years has a lot to do with wage flexibility...the lack of pay flexibility in the public sector - and the large increase in the wage bill - has been the prime reason for the big public sector job losses.

Does he have the causality the wrong way round? The higher average pay could be a consequence of the lower number of employees. The cuts have fallen disproportionately on the low paid, rather than managers in the public sector. Every employee earning less than the average who leaves the public sector nudges the average upwards. Salary bands, which he mentions, also play a part as fewer new staff are recruited and so fewer are on the lower steps of the salary ladder. By contrast the private sector has been recruiting but recruiting more at the bottom end and so pushing down on the average.

It is a pity he didn't consider whether the statistics were comparing like with like between 2009 and today. This kind of story can turn into conventional wisdom and become lodged in the political discourse. It needs to be challenged from the start. Careless use of statistics can lead to poor policy.