Artificial interest rate adjustments do not make sense.

 

 

 

Abstract.  There is no evidence that recessions are caused by a failure of interest rates to fall, thus dealing with recessions via artificial cuts in interest rates makes as much sense as dealing with the failure of a car to accelerate properly because of a faulty carburettor by strapping a jet engine onto the roof of the car, rather than by fixing the carburettor.

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 It is widely accepted in economics that interest rate cuts are a good way of dealing with recessions, and conversely that an interest rate hike is a good way of damping down excess demand and inflation.

Only slight problem there is that those interest rate adjustments (engineered by central banks) are entirely ARTIFICIAL, and it is widely accepted in economics that while changes to the price of anything brought about by market forces are normally justified, artificial adjustments are not.

Worse still, there is no evidence that recessions are caused by market failure in the sense of interest rates failing to fall, come a recession. Put another way, the market in loans is very much a free market: there are tens of thousands of potential borrowers out there and hundreds of banks and similar, all offering loans. That’s the sort of set up where it is difficult to set up monopolies and cartels: i.e. it’s a set up where the free market works.

To summarise, to implement an artificial cut in interest rates so as to deal with a recession, when the cause of the recession is quite clearly not a failure of interest rates to fall is like dealing with the failure of a car to accelerate properly due to a faulty carburettor by strapping a jet engine to the roof of the car rather than deal with the faulty carburettor.
 

So what is the cause of recessions?

Well it’s pretty obvious: it’s a failure to spend, or if you like, inadequate aggregate demand, maybe caused by lack of consumer or business confidence. Ergo the solution is  . . . . wait for it . . . . more spending: public spending and or private sector spending. And that can be brought about by a larger deficit, i.e. by fiscal measures rather than interest rate adjustments.

Of course, supporters of interest rate adjustments claim that fiscal changes cannot be brought about quickly. Well the first answer to that is that interest rate changes do not have their full effect for a year according to a Bank of England study. Secondly, the UK implemented two changes to the VAT sales tax very quickly in the wake of the 2007/8 bank crisis.

And how difficult would it be for the UK government to tell every hospital, doctors’ surgery, school, university and local authority in the country that they can up their spending by X% over the next 12 months, and that a cheque will be in the post? I mean would it really take a genius to do that?