Should the Bank of England raise interest rates? What factors should be most important for their decision?
When the Bank of England’s Monetary Policy Committee (MPC) changes its official interest rate – known as Bank Rate, it is attempting to influence the overall level of activity in the economy in order to keep the demand for, and supply of, goods and services roughly in balance. Doing so results in a rate of inflation in the economy consistent with the Bank’s 2% inflation target.” (How does Monetary Policy Work? | Bank of England. 2017. [ONLINE])
Following the financial crisis of 2007-2008 the central banks of most developed nations have set interest rates at historically low levels, in an effort to stimulate consumption and investment. This happens because the rate of interest that the Bank of England pays on reserve balances held by commercial banks and building societies has been reduced, encouraging the banks to issue loans, as they seek to achieve higher returns.
Presently, the UK inflation rate is at a five-year High of 3.0%. The decision to leave the European Union resulted in a sharp decline in the value of Sterling, which means that imports have become more expensive and inflation has risen 50% above the BoE’s 2% target.
As well as a high inflation rate, the UK is also being hampered by the lowest productivity growth rate of the G7 nations. Whilst it is true that most other advanced nations have experienced a slowdown in productivity following the financial crisis, the UK has failed to return to the stable pre-crisis productivity levels of ~2% per annum.
Mr. Carney, Governor of the Bank of England, says that poor investment and productivity growth is “the biggest part of the story”, but that Brexit has had an impact too.
Mr. Carney commented that whilst low interest rates can be used to prop up demand and stimulate growth, it hasn’t boosted investment to any high level, nor has it prepared the economy for a great rebound into a new business cycle, in this case. Instead, long-term economic growth and prosperity, and higher wages, are created by increased productivity. (The Telegraph. 2017. [Online])
Aside from the productivity concerns, the ongoing uncertainties of BREXIT should be a major factor when considering a change in interest rates.
Mortgage holders should also be considered, however, 57% of homeowners are currently on fixed-rate deals, so will be unaffected by interest rate changes in the short-term.
Throughout my life, I have noticed a very perplexing trend within consumption – people often spend far more than they can afford, for various reasons. But why shouldn’t they? To simplify the process of buying a house you require credit rating, and in order to achieve a strong credit rating you have to spend money on credit (often with very high interest rates). Punishing those that have chosen to maintain a debt-free lifestyle, by making it harder for them to use their savings towards joining the property ladder.
As aforementioned, the central banks of most developed nations responded to the financial crisis by slashing interest rates to historically low levels in an effort to stimulate consumption and investment. The central banks, at a time of unprecedented international austerity- the result of a debt fuelled financial crisis, are pushing savers to needlessly spend and perhaps increase their debt, to prop up a broken economy.
Instead, wouldn’t there be merit to be found in a more long-term approach? After all, the damage is already done, is it not? By maintaining interest rates of just below 6%, or indeed increasing interest rates to further encourage national saving, could establish a far more secure foundation for the nation to move forward from. We should instead consider that higher interest rates increase investment, by reducing speculation.
If interest rates are high (or quite frankly, anything above the negligible rates currently offered) the opportunity cost of investing savings goes up, along with the cost of that investment failing.
It is of course most likely that consumption in the short-run will fall, but, why the devil shouldn’t it? We’ve just had a God damn financial crisis!
It is of course also inevitable that there will be an increased cost to mortgages, but again, it is very possible that this cost can be negated after a period of increased interest rates, as first time buyers will be encouraged to save for longer, and therefore have a larger deposit to secure a smaller mortgage with.
The Independent reported that low interest rates revived the economy, but now we’re all suffering for it. “A 35-year-old needs to invest £125,000 to earn a pension of £35,000 when the interest rate is 5 per cent. If it’s 2 per cent, they’ll need to save £400,000.” (The independent. 2017. [ONLINE])
No easy solution exists, however, isn’t it time we start rewarding savers? After all, they’ll be the ones charged with bailing all of us spenders out again, when the next bubble bursts…
-Seth Wilkinson
BIBLIOGRAPHY:
How does monetary policy work? | Bank of England. 2017. How does monetary policy work? | Bank of England. [ONLINE] Available at: http://www.bankofengland.co.uk/monetarypolicy/Pages/how.aspx. [Accessed 22 November 2017].
The Independent. 2017. Low interest rates revived the economy, but now we’re all suffering for it | The Independent. [ONLINE] Available at: http://www.independent.co.uk/voices/low-interest-rates-revived-the-economy-but-now-were-all-suffering-for-it-a6982256.html. [Accessed 22 November 2017].
The Telegraph. 2017. Britain’s productivity crisis is biting hard â and the Bank of England is powerless to stop it. [ONLINE] Available at: http://www.telegraph.co.uk/business/2017/11/02/britains-productivity-crisis-biting-hard-bank-england-powerless/. [Accessed 22 November 2017].
