It has chosen to raise interest rates—but small corrections to monetary policy are unlikely to do much goodby George Magnus / November 2, 2017 / Leave a comment
For the first time in ten years, the Bank of England’s Monetary Policy Committee has decided to increase interest rates, from a record low of 0.25 per cent to a still weedy 0.5 per cent. There has been a good old brouhaha in the economics community over the last few weeks about this, and it is worth weighing the arguments even after the decision. While this 0.25 per cent rise is not a game-changing outcome, the Bank’s future behaviour with regard to interest rates could be, especially in relation to other things, including, of course, Brexit.
The Bank’s mandate is to keep the rate of inflation stable at around 2 per cent. As we all know, inflation is 3 per cent, but largely because of the effects of the post-referendum decline in the value of Sterling. This should wash out of the inflation data over time, unless of course Sterling were to carry on falling. On this basis alone, the question is why raise rates?
Moreover, there has been no echo of rising inflation in the labour market even though we have record numbers of people in work, and low unemployment. In the nerdy world of economics, this is captured by the flatness of what is called the Phillips curve, a tool that is designed to show how falling unemployment and rising wages are correlated. Except that in the UK and elsewhere, they haven’t been. The stagnant growth of wages suggests that full employment is not as full as the headline data suggest. The argument then runs that we should push the unemployment rate even lower, maybe to 3.5 per cent, until such time as wages finally do start to rise.