In an article by Richard Murphy entitled “Has Carney taken leave of his economic senses?” Murphy claims that Carney, governor of the Bank of England is wrong to say that interest rates should be raised given a significant rise in business investment spending.
Murphy says “What Carney is saying is that if business tries to improve UK productivity, or if it tries to increase employment, or if it tries to deliver growth then he will snub it out.”
Well first off, a rise in interest rates WOULD NOT entirely “snub out” that extra investment. The reason is simple and is as follows.
Assuming the economy is currently as near capacity as is feasible without excess inflation kicking in (i.e. NAIRU, which is where Carney seems to think it is, rightly or wrongly), then an £X increase in spending caused by extra investment needs to be countered. But there is no reason that “countering” (i.e. cut in spending) needs to be CONCENTRATED on business investment, and indeed it wouldn’t be in the event of an interest rate increase. That is, a rise in interest rates hits ALL FORMS of capital spending, including the sale of household “capital” items like fridge freezers, cars and TVs.
Thus a rise in interest rates would not entirely negate the above original rise in business investment.
Abandon the inflation target?
Next, Murphy suggests we should dispose of the 2% inflation target. He needs to explain whether that means abandoning all attempts to control inflation or whether it means raising the target to 3% or 4%. The former would be regarded as ridiculous by 99% of economists, while the second is widely seen as a possibility, while being contentious: not something we should do at the drop of a hat.
Let’s rob creditors!
Finally, Murphy says in relation to sticking to the 2% inflation target “And remember, the greatest beneficiary of this policy are the best off because low inflation preserves the real value of the debts the wealthiest are owed by the very many who owe them.”
Well the flaw in that argument was nicely illustrated in the 1970s and 80s. That is, it’s true that the sudden rise in inflation in the 70s hit creditors. But creditors are not completely stupid: they reacted (towards the end of the 70s and 80s) by demanding a higher return for lending out money. In fact the 1980s saw the highest real interest rates for at least half a century, presumably because creditors with memories of having been stung in the 70s, continued to demand high NOMINAL returns on their money despite the fall in inflation in the 80s.
A repetition of that period of high real interest rates lasting several years would of course not benefit the group that Murphy wants to benefit, namely borrowers.
And finally, borrowers are not all paupers: some people borrow a million or two to help them buy five million pound houses.
From what I have read Carney is against interest rate rises.Here is a piece from the FT from Carney's Mansion House speech
ReplyDelete"In his Mansion House speech, the full quote was: “From my perspective, given the mixed signals on consumer spending and business investment, and given the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time to begin that adjustment.”
One sentence looks to the future, the other comments on the past. Economists, who examine the words more carefully than currency traders, thought the two were consistent with each other. "
Hope that helps.
However what a load of hot air about a 0.25% rise.BoE is as always behind the curve,the market dictates and the BoE follows not the other way round.Didn't you do a post on that recently?
Interest rate adjustments have never worked particularly well.Though I have noted that he has put bank buffer capitals up 0.5% too....waste of time as well seeing as he will undo it come a bank crisis.Really why do we pay these bods at the BoE for all of this?