Friday, 5 August 2016

The Bank's interest rate cut:: pushing on a piece of string.

So the Bank of England yesterday lowered the interest rate from half a per cent to a quarter per cent, and producers and consumers have joyfully hit the streets, the former to invest and the latter to buy like crazy with such a low borrowing rate.

It was probably not Albert Einstein who said: “The definition of insanity is doing the same thing over and over again, but expecting different results,” but it is never-the less a good definition of the UK's economic policy.

After the crash of 2007/8 the interest rate was dropped from 5 per cent  to 0.5 per cent, and this, coupled with some orthodox Keynesian fiscal policy -  a tax cut  (VAT reduced from 17.5% to 15%) and some modestly increased infrastructure spending by the then Labour Chancellor, Alistair Darling -  averted a more serious recession  

 By the time of the election in 2010 the economy was once again growing, albeit slowly.

The Conservatives' Chancellor of the Exchequer in the new government, Gorge Osborne, now celebrating his elevation to the posh Companionship of Honour (you couldn't make it up) promptly put the process into reverse by raising VAT to 20% and introducing a regular series of annual cuts in government spending..

So the economy flat-lined for the next two years, then stumbled into a hesitant recovery, probably as a result of infrastructure expenditure sneaked in by the Liberal Democrat Businesses Secretary, Vince Cable, but is now, post Brexit, poised to dive again.

The chances of the Bank's action  by itself promoting a revival are negligible.

The case against relying exclusively on monetary policy to revive a flagging economy is at least 80 years old.  Keynes described it as  "like pushing on a piece of string."  His arguments  are no secret: they formed a prominent part of the A-level syllabus for most of my teaching career:

  • cheap money will not tempts investors to expand their businesses or found new ones unless they are confident of demand for their products.
  • cheap money will not tempt consumers to borrow unless they are confident about their future jobs and incomes. (This many be less true now than pre-the 70s, when unnecessary debt was, rightly in my view, regraded as immoral).
  • by expanding the money supply (now called QE) and relying on investors and consumers to take the bait, the government has no control over what actually happens to the money.  When the Tories tried it under Edward Heath (the Barber Boom) most of it went into commercial property.  Since 2010, rather than stimulating the productive economy, most of the cheap money has gone into shoring up the assets of the commercial banks, into asset prices, and fuelling the rise in house prices. 
If cheap money is to be effective in reviving  the economy it needs to be combined with fiscal policy: government spending where the government does not leave things to the caprices of the market but directs where the money goes.  There is absolutely no shortage of projects in desperate need of funds:

  • the NHS - especially training medical staff for when the flow from the EU dries up.
  • research and development, spearheaded by our universities.
  • improvements to the railway infrastructure - the existing networks rather than prestige projects like HS2.
  • repairs to the roads.
  • local authority expenditure, especially on  care for children and the elderly.
  • affordable housing, affordable housing, affordable housing.
  • technical education.
  • the arts.
  • the BBC, especially the World Service.
  • an improved social service safety net to protect the unfortunate.
  • renewable energy sources, especially tidal power.
  • maintenance of cathedrals, churches  and other buildings of historical interest .
Well, that's nice round dozen off the top of my head. It shouldn't be difficult to to think of a few more.  Keynes is alleged to have argued  that, if you can't think of anything better, pay some people to dig holes and others to fill them up again.  My own favourite on those lines has always been to bury the pylon line

Such projects provide employment, put money into people's pockets, revive demand and do useful things, so we end up with a more efficient, vibrant and civilised society.

Presumably our new Chancellor of the Exchequer, Philip Hammond, is thinking on these things for his autumn statement. He could start a few projects off now.


  1. I'd go further and say that the two major monetary policies of the last half century have both failed. Monetarism failed because it's impossible to control the quantity of money without causing bank runs. Inflation targeting caused a housing bubble because interest rate targeting relies on non-existent substitution effects for equilibrium transmission. The preference for monetary policy over fiscal policy has been a disaster for western society.

    1. Thanks. Great that at last we agree on something.

    2. You might be confusing me with an anonymous who is disagreeable.

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