Interest rates and inflation: The Right got it wrong

This post was written by Owen on July 18, 2012
Posted Under: Economy

Those readers of this blog with economics-geek tendencies (No? OK, just me then.) might have seen yesterday’s news that inflation is falling pretty sharply at the moment:

Retailers were forced to slash the price of summer clothes and shoes last month to tempt rain-drenched consumers into the shops, driving inflation to its lowest level since November 2009.

The Office for National Statistics said inflation measured on the consumer price index slipped to 2.4% in June, down from 2.8% in May, with clothing and footwear prices accounting for the largest downward contribution.

This is hardly a surprise. The economy is flatlining and has been for some time, as everyone’s well aware. This means that aggregate demand isn’t going anywhere (hence the fall in retail prices), which, combined with falling energy prices makes a drop in inflation pretty much exactly what you’d expect. Which in turn means that the Bank of England made the right call in keeping interest rates so low for the past three and a half years. The Monetary Policy Committee judged that the risk of worsening the recession by raising rates and choking off demand was greater than the risk of raising inflation by keeping rates low, and they judged correctly. Which is funny, because I’m sure I remember a hell of a lot of rightwing media outlets and Very Serious Economic Forecasters insisting that interest rates were going to have to rise to prevent runaway inflation, and that the ‘doves’ on the Monetary Policy Committee were naïve fools to think otherwise.* So, just for fun, I did a bit of googling. Here’s a sample:

UK interest rates must rise to 3.5pc, says OECD – Daily Telegraph, 27 May 2010

Bank hawk Sentance warns: we need to raise interest rates – The Scotsman, 30 December 2010

BOE Doves Living on Borrowed Time – Wall Street Journal, March 11 2011

BIS Says Central Banks Need to Raise Rates to Tame Inflation – Bloomberg Business Week, June 27 2011

My personal favourite, though, has to be everyone’s favourite Telegraph comment writer, Dan Hannan: libertarian, climate change denier and inflation-hawk extraordinaire. I feel a bit guilty having a go at him two posts in a row but he does present some open goals, bless ‘im. Hannan not only gave us a dire warning of impending runaway inflation as recently as three months ago, he even provided links in the same article to previous pieces he’d written making the same wildly wrong predictions, asserting repeatedly that prices are going to skyrocket any minute now. Since the much-maligned “experts” of the MPC turned out to be right and Hannan and his Austrian School buddies were wrong, can we expect a mea culpa from any of them any time soon? I have to admit I’m not holding my breath.

*It’s worth noting, of course, that while it’s heavily implied to be an essential policy that’s good for all of us, a rise in interest rates principally benefits those with savings in the bank and minimal debts – that is, (mostly) the rich – and hurts those with debt liabilities (i.e. the rest of us), but of course that’s a complete coincidence.

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Reader Comments

Owain

It’s correct that the interest rate rises mostly help those with savings, and are harder on those with debt, and vice-versa for interest rate falls. The big difference in who this affects though, isn’t across wealth divisions (rich v poor), but age divisions. This is because most people’s biggest savings are in their pensions, and there biggest debts is their mortgage. So low interest rates, with moderate to high inflation (let’s not forget, this fall in the CPI to 2.4% is still above the 2% that is the official target, and a fall from the higher values that have been the norm the last 2 years), benefit those of working age, with mortgages/rent to pay, and penalise those of retirement age, with pensions payouts and annuities linked to the BoE base rate, usually (I think).

Make of that what you will.

#1 
Written By Owain on July 19th, 2012 @ 11:02 am
#2 
Written By Owain on August 7th, 2012 @ 9:18 am

Well, food and fuel prices *could* spike, but a) I’ll believe it when I see it, and b) unless and until we’re seeing late 70s levels of inflation, raising interest rates is still a dumb idea that’s going to choke off economic recovery and hurt the poor a lot more than the rich. (And yes, I get that who benefits from high and low interest rates is partly generational as well, but I still think it’s far more a rich/poor thing. Not every older person has an annuity or index-linked pension, but pretty much every rich person has savings.)

#3 
Written By Owen on August 7th, 2012 @ 8:30 pm
Owain

I take your main point that a lot of commentators were overly optimistic about the economy recovering quickly, thus necessitating an interest rate rise. Long periods of low growth tend to follow credit bubbles (I remember reading somewhere), so the odds were never in favour of a quick recovery (no, not even if we’d followed Labours plan of spending slightly more, slightly longer).

But following the same principle that where mechanisms are unclear, the best guide to the future is to see what has happened in the past, interest rates now are at historic lows, and must rise at some point. And when (if?) the economy does start to recover properly, the quantitative easing, and cash stockpiling by businesses will make a lot of capital looking to come back into circulation. So while it’s right that interest rates are low now, and should be for some time, when the correction comes, it may need to be harder and sharper than previous corrections.

#4 
Written By Owain on August 8th, 2012 @ 5:07 am

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