1/18/2011

I highlighted how the MPC got it wrong last time. Will they learn their lesson ?

I'm going to show off a bit here, but I wrote, at length, three years ago about how the Monetary Policy Committee were totally wrong to keep raising interest rates before we went in to recession, in a fruitless and bizarre attempt to bring down inflation. As I wrote in June 2008

"Inflation has today risen to 3.3% from 3% last month. This is 1.3% above the government's target and is 1.2% up on last year. However, in the Monetary Policy Committee's own report they state that 1.1% of the 1.2% inflation rise in the last 12 months is down to rises in electricity, gas, petrol, oil and food. In effect, the MPC admits that the rise is because of a rise in the prices of the basic necessities of life and not because of extravagant spending.

So why are the MPC talking up the prospects of having to raise interest rates again ?

It is an absurd situation that an economy which looks to be heading for a recession might be tipped over the precipice because the MPC might raise interest rates in order to stop people spending money on luxuries when the MPC's own figures show that only 0.1% of the rise in inflation is down to spending on non essentials."
And before that in April 2008 I highlighted the total folly of raising interest rates when I explained


My circumstances are that our three year fixed rate mortgage comes up in the Autumn and it will mean an increase of around £100 per month to out mortgage repayments. Yet if you look at my pay rise for the last three years added together I am now earning just about exactly £100 a month more after tax than I was three years ago. Meaning I will have effectively had three years worth of pay rises wiped out.
Now multiply this across the country, with millions of people's fixed rate deals all coming to an end and more and more people having to pay more for their mortgages, and what's more, tying themselves down to a set rate for three or five years. In effect, this means that we are not only going to see a recession in this country because of the effect of people paying more for mortgages (to pay for houses that will be dropping in value), but the system ties people in to paying recession prices mortgages for some years to come, thus stopping the cycle of money that might kick start a growth out of recession.

So where are we now ? Inflation has risen to 3.7%, because of "rising fuel, energy and food prices". Its June 2008 all over again. Will raising interest rates and removing money from people's pockets stop people buying food, fuel and energy ?  Of course not, they are basic essentials and not excessive consumer spending.

Will the MPC have learnt a lesson from 2008 ? You'd hope so, but some of the same clowns from 2008 still sit on the committee, so I wouldn't put it past them to make the same mistakes again.

10 comments:

Alan said...

Yup - looks like they're going to make the same mistake - we got into this mess because interest rates were kept too low (because house prices are not included in their measure of inflation). Hence we get an asset bubble. It 's the classic "Greenspan put" - negative real rates feeding a bubble.

Now, we should be getting back to normal base rates of 4-5%. Instead, they are keeping them at an artificially low level with continuing negative real rates encouraging people to take out reckless(*) mortgages, and hoping to reinflate the housing bubble.

(*) Anyone who didn't factor in the long term normal mortgage rates (about 7-8%) when taking out a 25 year commitment is a reckless borrower, in my opinion, and the primary cause of the last recession.

Norfolk Blogger said...

The reclklessness was not to cut rates in 2008 earlier rather than what the MPC dud, which was to raise them. It would be reckless to raise them now.

As I clearly pointed out, inflation is rising due to things outside of the control of interest rates ( fuel and food) . If rates went up, people would still buy these things. Any rate rise would show a reckless misunderstanding of what is going on in the economy.

Alan said...

Yes - but in two years time, rates will need to back at 4-5%.

We can do this gradually, a little bit at a time, or all in a rush.

Personally, I prefer the former, giving people time to adjust. The alternative is massive housing defaults as rates go up tenfold in a few months.

The MPC have a track record of acting too slowly and then panicking - too slow to raise rates in 2002-2005; too slow to cut them in 2008; and too slow to raise them now.

Gentle rate rises will not impact the recovery (other than keeping house prices down - not a bad thing). Rapid ones will.

Anonymous said...

Interest rates are low because if they rise then a large number of people in the country will be totally fucked with their mortgages (among other loans they can't afford) and no party could cope with the animosity and possible disturbances that may result.

Apparently three million people are already between 0 and 6 months in arrears on their mortgages...

those billions used to bail out the banks seems like a worse deal every day

Alan said...

But interest rates should be set independent of political pressures. Failing to deal with a problem now makes it worse in the future (a sudden tenfold increase in rates) - that's exactly how it used to be before BoE independence.

And secondly - what billions to bail out the banks? The government made some guarantees which were never called upon (hence no cost to taxpayer - in fact they charged for this and made a nice profit). They bought some shares in two banks, which are now worth more than they paid for them (hence a profit for the taxpayer). They extended the range of assets accepted for reverse repo, but none of these have defaulted (hence no cost to the taxpayer).

I'm afraid you've been suckered by the media (and the Labour party) into thinking that taxpayers' money was actually spent!

Anonymous said...

Firstly, I don't listen to the Labour Party so there's no need for your childish prejudices.

Secondly, I see that you're proposing that the banks have actually made the taxpayer richer by being 'bailed out'. Amazing. I can't understand why everyone and his dog was making it out to be a bad thing.

And absolutely everyone bar you refers to it as a bailout - from Robert Peston to Edward Leigh and David Cameron.

Thirdly, were the National Audit Office totally wrong when they stated that the final cost to the taxpayer of the bailout would be between 20bn and 50bn (dependent on the sale of Govt stakes?)

Alan said...

The banks were bailed out - with a guarantee that, in the event, was not needed and so cost nothing. Had it been needed, it would have been very expensive indeed.

Re those made-up NAO figures - total rot.

The NAO have to take a very pessimistic view about asset recovery, and even they say it will break even. A simple Google search will yield many similar articles.

All of this is regularly covered in, say, Radio 4's More or Less, or the business pages of any reasonable newspaper.

Disclaimer: not a banker; just numerate.

Dan said...

Nich - your economic knowledge isn't as good as your political knowledge.
"inflation is rising due to things outside of the control of interest rates ( fuel and food)"
Inflation is rising as there is a loose monetary policy being followed. Consequently, too much cash is chasing too few goods. Consequently, higher prices. And as the pound devalues, the cost of imported goods rise in a vicious circle.

Of course, the BoE and Govt know exactly what they're doing and although haven't said publicly, they have ceased targeting low inflation for 2 reasons:

1) As mentioned above, the fear of a collapse of debt if rates were to rise.

2) Higher inflation eats away quicker at the high national debt.

Sir Norfolk Passmore said...

Your mistake here, Nich, is that you're confusing relative price levels with a generalised increase in prices.

At any given time, different prices will rise (or fall) at different rates due to changes in relative levels of demand and supply. But this is purely a RELATIVE phenomenon. It doesn't at all mean that (say) increases in the prices of food and fuel are "causing" inflation as newspapers crudely report it. You would see precisely the same relative changes were the inflation rate 20% or -10%.

It has been almost universally accepted for a quarter of a century by economists worldwide (including neo-Keynsians) that the generalised increase in prices which is (by definition) inflation is a monetary phenomenon.

Separately, you also ignore the fact that people save/lend as well as borrow. High interest rates clearly have an impact on people with large mortgages. But equally, low interest rates are disastrous for those with savings and fixed incomes. Yes, higher interest rates discourage borrowing/current consumption and encourage saving/future consumption, but that is far from being an unambiguously bad thing as you seem to suggest.

Love Norfolk Blog said...

Doesn't look as if this will change any time soon. And to think I'm looking to buy a house. I must be mad.

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