It is time to stop spoon-feeding the banking systemby Marian Bell / September 18, 2014 / Leave a comment
Attention has turned to just how far and how fast interest rates will rise in Britain, and what the impact on the UK economy will be.
The Monetary Policy Committee of the Bank of England responded to the financial crisis and deep and prolonged recession by sharply reducing the bank’s interest rate to a historically low 0.5 per cent, and by buying £375bn of assets from the non-bank private sector, in a process known as quantitative easing. The aim was to reduce long-term interest rates, boost the money supply and support asset prices. This dramatically loosened monetary stance was fully in place by July 2012.
Earnings, when adjusted for inflation, are falling, so it will not feel like a recovery to many people—but the UK’s economic output has now surpassed its 2008 pre-recession peak, marking the end of an unusually long slump in output. The economy is expanding at a brisk pace, business investment is growing, and momentum and confidence are building, particularly in the southeast, and in the service sector. Forecasts are for growth of more than 3 per cent this year—the fastest among the world’s advanced economies—and close to the same rate next year.
As the economy returns to normal, this “exceptional monetary stimulus,” as the MPC itself has described it, is no longer appropriate. There is probably still a fair amount of slack in the economy—output per head remains well below pre-recession levels—and there is little sign of inflation. But the MPC should start raising rates from abnormally low levels long before spare capacity is completely eroded, not least because rate rises will have to start gradually.
There is considerable uncertainty about the economic impact of an increase after a sustained period of unusually low rates, particularly its effect on highly indebted households. It is not clear how the commercial rates faced by savers and borrowers will respond. By the time the economy is running at full capacity and inflation is threatening, it will be too late to start a process that may have to proceed very slowly, calibrating the effects of higher rates as it goes. The purpose of a gradual tightening of monetary policy starting now…