Monetary madness

The Monetary Policy Committee might manage a 0.25% cut in their recommended rate at the next meeting or they may delay further.

Why does the MPC always want to get it wrong? They failed to put interest rates up enough in the days of easy credit. Their failure meant too much borrowing and a big increase in inflation. Now when it is obvious to anyone that the problem is too little credit and falling prices of most things, they stubbornly refuse to cut the rates enough or quickly enough. America slashed her rates to only 2%. She too had rising inflation at the time but realised that in future inflation will tumble.

Some people now say there is no point in cutting the recommended rate because market rates will stay much higher. At some point the Bank of England has to get back in charge of the markets. In the meantime, cutting the recommended rate will help all those borrowers whose actual interest rate is linked to the Bank of England rates.

If interest rates remain too high it just means many more bankruptcies and many more lost jobs.

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27 Comments

  1. John
    Posted October 2, 2008 at 11:18 am | Permalink

    The savings rate has turned NEGATIVE. The problem is prices are going up too fast, people are spending too much, and saving too little. Listen to your leader – we have to break the debt cycle and control prices. That means making it more attractive to save, and less attractive to spend. It means putting rates UP. They will soon be negative in real terms if cut further.

  2. APL
    Posted October 2, 2008 at 1:29 pm | Permalink

    JR: “Why does the MPC always want to get it wrong? They failed to put interest rates up enough in the days of easy credit.”

    It is packed with political appointees, Gordons Cronies?

  3. Kit
    Posted October 2, 2008 at 2:40 pm | Permalink

    "those borrowers whose actual interest rate is linked to the Bank of England rates"

    Who are these borrowers? Are they the ones we should encouraging to borrow? Have you considered the unintended consequences of distorting the market that this move will make? (Slashing interest rates will kill the pound.)
    We are already in the situation where the government is not the lender of last resort but the lender of first choice. I think historians will look back and see that the government interventions prolonged and deepened the crisis.

  4. Acorn
    Posted October 2, 2008 at 2:42 pm | Permalink

    Don't forget the savers who are linked to base rate. We are desperately short of savers at the moment. But; they want to know that their bank will still be there tomorrow! Murphy; get that jug of Potcheen out, I am on my way; you know; the one that smells like Castrol GTX.

    Anyway, the crunch is down to Clinton and a few vested interests who in 1999, got the US Congress to repeal that 1933 Glass-Steagall Act. see:-
    http://www.financialsense.com/editorials/engdahl/

    John, did we have a similar Act that got repealed at that time, Gordo must have had his fingers in this one?

    Finally, have a look at this video and pray we don't have similar; remember Bradley Stoke? "Foreclosure Alley", see:-
    http://kcet.org/socal/

  5. Tony Makara
    Posted October 2, 2008 at 3:05 pm | Permalink

    The MPCs sole remit now is based around maintaining the value of Sterling, which has certainly taken a buffeting of late, but will weaken considerably further if the MPC is seen to be following a rate cutting agenda. All this must make us question the wisdom of floating currencies and our nations depedence on imported fuel and food. Yes, we absolutely do need to cut rates, but because of the fragile position of the Pound and because of our import-culture we cannot, we dare not, cut rates, not without importing inflation. Time to think about taking us out of the EU and developing an internal market Mr Redwood? We can't continue to suffer these swings of boom and bust.

    • APL
      Posted October 2, 2008 at 10:42 pm | Permalink

      Tony Makara: "All this must make us question the wisdom of floating currencies … "

      No.

      Tony Makara: " .. and our nations depedence on imported fuel and food."

      Yes.

      Tony Makara: " ..but because of the fragile position of the Pound .."

      The pound is fragile because 48% of the GDP of the country is spent by the government, an unspecified amount is committed to off balance sheet PFI, and Brown has declared his intention to borrow more to support his reckless spending plans.

      • Tony Makara
        Posted October 3, 2008 at 12:16 am | Permalink

        No doubt that Sterling has been overvalued for far too long and the blame for that must lie with the MPC for keeping rates too high for too long. The problem we now face is how to bring the Pound down to a more natural value without undermining confidence in the currency and sending it into freefall, with all the implications for sudden and shocking price increases on the back of imported goods and the resulting pressures on wages.

        Gordon Brown, as a politician, has been happy to let the Pound punch far above its weight, knowing full well that it was a scenario that could not be maintained indefinitely, the strong Pound kept the fake feelgood factor going for the Labour government as consumers lavished credit on cheap imports.

        This is all about balance and allowing Sterling to operate at a level that serves the national economy best. Unfortunately the more we import the stronger Sterling has to be and that means higher interest rates to support the currency. Once we begin to develop more of an internal market we can escape the need for an overvalued Pound, higher interest rates, restricted liquidity and the dreadful shock therapy that our economy has to endure evertime the Sterling rises and falls.

        Reply: Sterling has been on the slide for months, despite the high interest rates. Lower sterling is part of the answer, as the UK is not competitive enough. There is no need to engineer a devaluation -we are getting one becuase our public accounts are in such a mess.

        • APL
          Posted October 3, 2008 at 9:10 am | Permalink

          Tony Makara: "No doubt that Sterling has been overvalued for far too long and the blame for that must lie with the MPC for keeping rates too high for too long."

          How can you reconcile your view that we should abolish floating currencies and fix the rate of our currency, with your comment that the board that that currently tries to fix the rate of sterling (by making it more or less attractive for foreigners to hold) has been fixing the rate incorrectly?

          If as you say the MPC', has tried to fix sterling at the wrong rate, what is there to stop your 'monetary authority' from fixing sterling to, for example the US$ or the EURO at the wrong rate permanently?

          Tony Makara: "The problem we now face is how to bring the Pound down to a more natural value without undermining confidence in the currency"

          How do you know the rate you choose is a 'more natural' rate? What criteria would you use, when all other countries exchange rates are fluctuating?

          How do you know the right 'more natural' rate for sterling this week, will be the right 'more natural' rate next week, when circumstances in the various world economies have changed?

          In fact Tony, you don't and it won't.

        • Tony Makara
          Posted October 3, 2008 at 3:03 pm | Permalink

          APL, unfortunately we are constantly playing catch-up and are in the business of damage limitation. In answer to your question about fixing rates, the answer lies in the establishment of a world currency to run alongside existing national currencies with fixed exchange rates that can be upgraded periodically depending on the individual circumstances relating to each national economy. Under the floating system nations that rely heavily on imports have to have higher interest rates to keep their currency overvalued, all to prevent inflation entering the country on the back of imports. The fact that the very value of our currency is determined by money-lenders and speculators is ridiculous, we need a steady system of value, one that is open to periodic adjustment and not subject to the whim of arbitrage. The floating system is a major factor in boom and bust as the higher interest rates needed to support the currency impact on liquidity with the alternative being inflation.

        • APL
          Posted October 3, 2008 at 5:46 pm | Permalink

          Tony Makara: "In answer to your question about fixing rates, the answer lies in the establishment of a world currency to run alongside existing national currencies with fixed exchange rates that can be upgraded periodically depending on the individual circumstances relating to each national economy."

          Sorry, it seems to me, you are advocating additional complexity which to me is counterintuitive.

          If I want to trade with Germany, I will buy Euro's to do so. I don't want to buy a world currency fixed at some arbitary rate and then convert that back to Euros. That is just naff!

          The real solution to the issue, is not to set up a world government – God haven't we got it bad enough with the European Union or the United Nations – but to fix our economy, reduce government spending, eliminate governmentally induced bias to behaviour that currently destroys our competetiveness.

  6. figurewizard
    Posted October 2, 2008 at 4:02 pm | Permalink

    There are two good reasons why the Bank of England should not cut rates Mr. Redwood. The first is, as you point out is that any cut would merely serve to increase the margins of the banks. This would be especially so in the case of the least deserving ones who served to get us into the mess we are in today. The second is the international value of the pound. Three weeks ago on the 11th September the pound / dollar rate stood at $1.75. Less than two weeks later; on the 23rd it had risen 6.2% to $1.86 but today; just nine days later it is trading at £1.76 down again, by 5.4%. If the Bank takes no account of the principle of sound money at present when currency fluctuations are as violent and unpredictable as this we could risk a run on the pound that would spell disaster for inflation and force future rates upwards to a far greater level than they stand at today.

    Reply: the dollar rose after they cut rates. We need confidence in our economy, which these interest rates are helping to throttle.

    • figurewizard
      Posted October 2, 2008 at 10:12 pm | Permalink

      I fail to see how lowering rates now could increase confidence in our economy Mr. Redwood. Quite apart from the sad fact that Gordon Brown is still running the country, the decision by the Irish government to guarantee all deposits without limit, just as Northern Rock has started to turn them away means that a flood of savers' cash is beginning to pour out of the UK. What with this and a fragile pound an interest rate cut would simply pour fuel onto the fire.

  7. mikestallard
    Posted October 2, 2008 at 5:43 pm | Permalink

    Gordon Brown proved his financial wizardry with the claim that he had freed up the Bank of England from the Tory Tyranny. For those of us old enough to remember the period 1995-1997, it was a period when dear old Ken Clarke presided over a good economy, in friendly relationship with the Bank.
    Now, of course, we see the Labour politicians of the MPC, the grimly suited Eurocrats of the FSA and the gormless, penniless Treasury completely at loggerheads.
    It is, apparently, rumoured that Gordon (in cohoots with the Guardian's article) is about to join us into the Euro!

  8. Kit
    Posted October 2, 2008 at 9:40 pm | Permalink

    "Reply: the dollar rose after they cut rates."

    The US Treasury sold foreign currency to buy dollars and the dollar still holds a safe haven status which helped the dollars rise. Neither of these effects will save the pound.

  9. Robert
    Posted October 2, 2008 at 10:12 pm | Permalink

    John, so penalise the prudent and save the reckless! As I have explained before, rates in this deleveraging cycle will have minimal or a very limited impact. Why? Well as you mentioned yourself the Banks may not pass much, if any, of a rate cut on. They need to rebuild their shattered balance sheets, and the wholesale market will remain shut or dysfunctional for the foreseeable future. A rate cut may possibly alleviate some pain for a few at the margin , but capital will be in short supply and will be priced accordingly. Yes, I agree that rates should be on a downward path as inflationary pressures are finally abating as weaker demand is kicking in. It is inevitable that we go through a recession, depressing as that is! Consumption has to slow to rebuild the savings ratio, our economy for too long has been too dependent on consumption and government spending, both are a busted flush.

    • mikestallard
      Posted October 3, 2008 at 8:37 am | Permalink

      What is to stop someone setting up a bank which depends on both sides knowing who they are lending to and just keeping money safe for investors? If it were run by , say, Quakers who are widely known for their honesty, what would there be to stop people investing there? At least your money would be as safe as anywhere else.

      • figurewizard
        Posted October 3, 2008 at 3:07 pm | Permalink

        One famous bank set up by two Quakers; messrs. Overend and Gurney specialised in financing trade between Great Britain and the Empire. It was set up in 1800 and thanks to careful management and excellent service their bank eventually became the largest in the country. By 1866 however the founders were long gone and a new breed of managers had taken control. The allure of the booming development in dockyards and canals at the time inspired them to invest heavily in these so as to get better returns. However the boom subsided and because short term debt had been used to supplement depositor funds to be invested in long term projects, they began to run out of cash. Thus in 1866 there was a run on the bank causing them to fail; something that was not to be seen again until – Northern Rock.

        • mikestallard
          Posted October 3, 2008 at 5:25 pm | Permalink

          Time for a rerun?

  10. APL
    Posted October 3, 2008 at 12:10 am | Permalink

    Since we are clearly in a position where we need every penny we can find. Let's tell the European Union politely* where to go and save the £10b per year currently paid to the Eurocrats, and spend it instead on propping up our own banks.

    *Self edited, my preference was for a far more robust Anglo Saxon phrase.

  11. mart
    Posted October 3, 2008 at 3:16 am | Permalink

    Dear John, I find you persuasive on this subject, and am coming round to your view.

    Until recently I thought we had inflation prospects in our economy. Now I think we have severe recession prospects.

    I previously thought we had the prospect of re-inflation of house prices if rates were lowered. Now I think that there is a mood of sobriety in the British public and this risk has receded.

    The big change to change public perceptions, in my view, is the huge news story of the bail-out votes in the USA. The pronouncements by prominent US politicians on this subject have been so very sobering, I think the British public cannot fail to have been struck by it.

    We have also had, in the last few days, the rescue of the B & B.

    In summary, I now take your view that interest rates ought to be lowered by the MPC.

    However, one wonders what use this is, if banks are so chastened about their inter-lending rates, and are looking (as I see it , anyway) at the mood of the market rather than at the BoE official rate.

    Thank you for blogging every day. I almost always read.

  12. DBC Reed
    Posted October 3, 2008 at 10:25 am | Permalink

    The problem,as always, with lowering interest rates to stimulate demand in the Keynesian manner is that a lot of the new credit goes into land and property.This was an oversight by Keynes who was conversant with an earlier money reform scheme from Silvio Gesell,half of which dealt with this diversion of new money into land/property.(See Carol Wilcox's letter to Guardian 2.x.08.)
    There is no way the MPC can do its job with new credit disappearing sideways out of the production -consumption loop into property. They should down tools until the Guvment do something about it. Keynes thought that Gesell's schemes on land and property were inspired by Henry George, so perhaps the Guv should cut out the middleman, and go back to George and his tax on land values.
    People may dimly remember that this crisis stems from a property bubble but seem less aware that this bubble was induced by the free market (as per classic Georgism)and the efforts of politicians to spread the free-market benefits of home-ownership to as many people as possible. George Bush's original recipe for disaster is still on the Net accessible by Googling: Fact sheet Bush Ownership Society.
    But the paper trail goes back to Clinton (see APL's posting of NYT story from30.ix.08 1999 on this site) and before that Carter's Community Reinvestment Act.
    In the Uk ,all the political parties have pushed home-ownership,but the Conservatives have led the way and their abolition of Schedule A on owner occupiers in the 60's was the key change for the worse.

    Reply: There is no danger of lower interest rates at the moment creating a new property bubble!

    • APL
      Posted October 3, 2008 at 3:11 pm | Permalink

      DBC REED: "but seem less aware that this bubble was induced by the free market "

      DBC REED: "and the efforts of politicians to spread the free-market benefits … "

      Mr Reed, one contridicts the other.

      Either you have a free market, in which case politicians have nothing to do with it.

      Or you don't.

      Since you claim that politicians have been incentivising people to behave in a partucular manner, then clearly we do not have a free market.

      DBC REED: "George Bush’s original recipe for disaster is still on the Net accessible by Googling:"

      At the risk of covering old ground, Fannie & Freddie have distorted the market (in the US) and incentivesed a particular behaviour. That is not a free market, the distortion of the market predates Bush, you ought to get treatment for your Bush Derangemend syndrome.

  13. DBC Reed
    Posted October 3, 2008 at 11:23 pm | Permalink

    As I obviously did n't make clear, I feel all the political parties involved have plugged the property owning democracy line: Bush is by no means the worst,but the Republicans have a nerve calling the Democrats for it while the Ownership Society is still current. Bringing property ownership to as many people as possible is the Conservative stock in trade and they will be stuck without it should the property market seize up.
    It is possible for political parties to promote free markets, if only by deregulating and rolling back the State.(see above)
    It is becoming fashionable to say that lowering interest rates will not set off another housing bubble.(And this from people who did n't notice the present bubble when it was towering over them and did n't bat an eyelid when house prices doubled over two years in the 70s which should have been an instructive experience).
    We have n't seen the present bubble deflate all the way yet.
    Claiming we won't have another housing bubble if we lower interest rates (without a tax blocking cheap credit piling into property) is likely to be a hostage to fortune for those who've said it.

  14. Eddie Allen
    Posted October 4, 2008 at 8:13 am | Permalink

    DEBT is the 'free market economy'.

    DEBT ( or in PC ) "De-regulated markets", is the scourge of our planet.

    DEBT is simply the fulfillment of desire for things one can't afford.

    DEBT empowers governments which like to make lists of things to spend the extra revenue on and tell you how good THEY are.

    DEBT is the means to shackle the spirit and to rid mankind of an ability to protest.

    DEBT makes people feel good but only when they use it not when they pay it back.

    DEBT created an elite rich which divided societies.

    DEBT gets you that fancy car, that fancy house, that fancy holiday and a whole load of misery with a thing which holds no value.

    DEBT feeds the system and replaces manufacturing where men actually work, where they gather and argue, and where they demand more, and thus their protests are silenced by DEBT and their political influence is stifled by it.

    DEBT helped to kill democracy.

    DEBT feeds a faster burning environment which needs more taxes to stem the pace of it before it burns our planet.

    DEBT kills men, women and children and their thoughts, hopes, dreams and aspirations and our planet.

    DEBT makes men think they are bigger than they are and those who have it to make demands on others to change society to accomodate THEIR needs.

    DEBT is bad and in some cases evil.

    DEBT and all of the above can be beaten by a simple realisation that you don't need it if you rid yourself of desire.

    The world will then be righted.

    I remember before finance was deregulated when a credit card ( advertised as your flexible friend ), could not be used for normal everyday foodstuffs and many shops didn't even take them.
    Then, Tesco's and others got them in, caught on to the power of too easy credit ( thrown at people ), and started to compete with non-foods and clothing.

    Up went the bills overnight !

    I remember when 'saving up' was compulsory before getting a mortgage, and I remember when you were 'posh' to have one, and I remember when retailers didn't do insurances, loans, visa's and mortgages.

    The culmination of this madness ended in £1.4 trillion of personal indebtedness in the UK.

    Some people say it's peoples fault, no control etc, but I blame deregulation……frittered manufacturing bases, jobs for the boys and a lowering of personal esteem and commonsense.

    The governments did this not the people and yet they control every other facet of our lives !

    Debt has caused people and society to divide themselves with envy of thy neighbour instead of love and respect for someone in the same boat.

    But through it all, politicians carry out their programmes, fill up the services, knock down factories, and change the rules we live by whilst people are out "shopping" and taking not a blind bit of notice of what they do……just how much is it, ooo that's nice, and then the bills…..oh, I have £400 a month spare since I paid my car loan so that means I can get another loan !

    It means I can get a better car than my neighbour.

    I tell you, this world is full of idiots and it's time governments stopped feeding on their weaknesses.

    Gladly, there are many who are not and that's the only thing which makes me want to help to change it all, otherwise I'd just say stuff it.

    Me and Scrooge and the rest of my family will be having a whale of a time this Xmas with all the money I haven't bothered spending whilst many people are being evicted from their homes because of envy and greed, their own stupidity and because political decisions were made to deregulate the financial sector and and inflict easy credit on our citizens whilst simultaneously knocking out Britain's manufacturing base.

    "Someone" needs to Change it before Broken Britain sinks into a cesspit of debt and poverty.

    • mikestallard
      Posted October 4, 2008 at 9:00 am | Permalink

      Wow!

    • APL
      Posted October 4, 2008 at 10:50 am | Permalink

      Eddie Allen: "DEBT", "DEBT", "DEBT"

      Well, yes. Politicians encourage debt, while sneakily making use pay for their privileged lifestyle. It is a good short cut and alternative to building a really prosperous economy (based on credit rather than debt) while giving the impression of long term growth. I rather have come to the conclusion that politicians are a necessary evil, and for that reason we should have as few of them as possible.

      It is also one of the most annoying things about Mr Redwood's commentary, he is advocating punishing folk who wish to take responsibility for themselves and at least attempt to achieve a modicum of independence, and rewarding those who have taken advantage of the free or low cost debt and ramped up their borrowing. That doesn't seem to me a principled Tory stance.

      DBC REED: "Bush is by no means the worst,but the Republicans have a nerve calling the Democrats for it while the Ownership Society is still current."

      Reply: I agree we need more savings. Market rates are well above indicative rates from the Bank of England and will remain so. If we do not try to take some of the pressure off borrowers much more money will be lost by the banks, which is money they need to pay the savers.

      We may have a glimmer of agreement here. I did post a link to a New York times article that outlined not just how Clinton had 'deregulated' the market, but had actually brought in new regulations that actually forced banks and financial institutions to lend to bad risks.

      Now, I agree, most politicians are disposed to do the easy, popular action, likewise most people will take a gift when it is offered to them. It would have taken a very strong minded individual to roll back Clinton's 'reforms'. Neither of the two Bushes strike me as such.

      DBC REED: "It is becoming fashionable to say that lowering interest rates will not set off another housing bubble."

      In the next two or three years I cannot see how low interest rates will spark another housing bubble. Housing asset prices are falling ~10% this year, despite the spin the chances are we will see similar decline next year. Who in their right mind will buy a house where the price is declining just because they might save 1% on the mortgage rate?

      DBC REED: "We have n’t seen the present bubble deflate all the way yet."

      Agreed.

      But I think rather than encouraging debt, ( which has its place in an economy) we should be encouraging people to save. Or rather removing the disincentive to save, for a start abolish tax on credit interest. Next put the money supply out of the reach of government, and thus control inflation, which is currently used as in instrument of debt control by government. Cynically devaluing the currency in order to pay back its debt in devalued currency.

      • Alex Sabine
        Posted October 9, 2008 at 5:21 am | Permalink

        (I'm assuming, perhaps incorrectly, that the comment directly above is part of John's reply rather than APL's post…it's hard to tell as it's all in the same font.)

        Apologies for replying to such an old post, but I'm intrigued by your call to "next put the money supply out of the reach of government, and thus control inflation".

        This strikes me as a statement with potentially radical implications for the entire monetary system. Do you mean you want to:

        1. Strengthen central bank independence (in which case why are you, as a politician as well as a perceptive economic commentator, always urging the MPC to cut interest rates by large magnitudes?)

        2. Return to something like the gold standard or a commodity-backed monetary system to act as an 'automatic' discipline on inflation

        3. End fractional reserve banking, ie remove the role of the banking system in money creation

        Interestingly, the Thatcher governent argued precisely the reverse: that controlling the money supply was the government's chief economic duty; and that it was fully capable of doing so.

        The unhappy experience of 1979-81 showed that "controlling" the money supply was in practice a lot more difficult than simplistic monetarism assumed, especially since the attempt to do so coincided with financial liberalisation which disturbed the relationship between the money supply and the price level.

        (In any case, the British government was trying to influence the money supply indirectly through interest rates – the demand for money – rather than directly through open market operations/monetary base control; but both methods of control proved crude and problematic.)

        But in any case, dramatic 3% cuts in interest rates (potentially creating negative real rates, although obviously there's a large gap between official and market rates) is a novel way to control inflation. You may be right that it's necessary to ward off a deep recession, but by it's hardly Sound Money when inflation is running at 5%.

        It sounds to me like you in fact want to retain the discretion to stimulate the economy through lower interest rates when you deem them necessary.

        Which is a perfectly legitimate point of view and one Mrs Thatcher had a lot of sympathy with – after all, she repeatedly resisted recommendations from her Chancellors to make the Bank independent because of her desire to keep control of interest rates (and by extension the mortgage rates of 'her' people). It does, however, sit uneasily with notions of sound money, still less "putting the money supply out of the reach of government".

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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