Thursday, 5 November 2015

Is monetary policy all nonsense?

Positive Money, the New Economics Foundation and Richard Werner in their submission to Vickers argued that interest rate adjustments were a defective method of regulating demand.

Support for that idea comes from a recent Financial Times article which suggests the UK is not actually able to alter interest rates because UK rates are tied to US rates. The chart below is from the FT article. (The article is by Martin Sandbu and is entitled “Free lunch: is the Bank of England a slave of the Fed?”)

In contrast, fiscal stimulus in the UK (e.g. having the state spend more on health and education, or cut taxes ) results in demand rising in the UK, and not to too great an extent elsewhere. I.e. when spending on health and education rises, the extra pay that teachers, nurses etc get does leak out of the UK and boost demand elsewhere in the World to SOME EXTENT. For example teachers and nurses spend more on foreign holidays and imported cars. But plenty of that extra spending is confined to the UK.

Moreover, in that demand does leak out to elsewhere in the world, that means the pound falls on foreign exchange markets, which in turn discourages imports to the UK and encourages exports from the UK. Thus you could say that in effect, increased demand in the UK boosts employment in the UK and does not leak to imports.

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