Late and dangerous U turn by the MPC

The MPC should be changed, before it does any more damage.

In my New Year message at the end of 2007 I called again for lower interest rates. It was obvious that rates were too high, and they would bring many job losses and factory closures. Inflation would rise during 2008 owing to previous MPC mistakes, but would fall again in 2009.

As the MPC are intelligent economists, we must assume they could see that too. So why, now the magnitude of job losses and factory closures is becoming clearer, do they suddenly panic, and do what they should have done a year ago? Have they been pressurised by the government acting through the Bank of England?

I would normally welcome a major U turn by a group of powerful people who have got it wrong. However, on this occasion, they have missed another important change in the last few months. The government’s borrowing requirement has shot up from the £43 billion forecast in the Spring, to more than £120 billion.

The MPC should have written a letter to the Chancellor, saying that for inflation reasons they wanted to cut rates substantially, but they needed guidance on the likely size of the government deficit,given the impact this will have on the ability of the government to borrow enough money. They could have added, the more the government controls its deficit, the more they could cut interest rates.

We now have monetary policy at variance with fiscal policy. The Chancellor should take urgent action, to avoid the imbalance doing damage to his plans.

Just to show you how abnormal the economic world now is, a few hours after the large interest rate cut sterling is stronger and Uk share prices are down!

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25 Comments

  1. John Ledbury
    Posted November 6, 2008 at 5:44 pm | Permalink

    Dear JR, Bit off topic but why don't the tories go for dumping the council tax? Councils would still be accountable having to announce local surcharge on income tax & vat. Tax is paid proportionately by those who earn and spend most. Collection cost disappears, non-payers disappear, old age pension seems to have magically doubled. Cost of paying bloke to snoop on whether we live alone and to count our garage disappears… How can Cam et al continue to ignore this election winner?
    Best wishes
    John Ledbury

    • Stuart Fairney
      Posted November 11, 2008 at 8:08 am | Permalink

      If I may, because they are afraid of the issue, they refuse to countenance radical action and so prefer to ignore it and hope it will go away.

  2. michael, islington
    Posted November 6, 2008 at 5:47 pm | Permalink

    Explain your reasoning.

    As I understand it, you say the bigger the government borrowings then the less scope there is for cutting interest rates.

    Conversely, the lower the government borrowings …

    Why?

    Reply: Because they need to offer an attractive rate to persuade investors to cough up so much cash.

  3. Lola
    Posted November 6, 2008 at 5:50 pm | Permalink

    Your are right, but it could be that they have done this to help borrowers and banks by giving space between base rates and lending rates to permit a good spread. This would help the commercial banks rebuild their balance sheets without overmuch pain to residential and commercial borrowers. But of course it's not the rate we pay that is the issue – it is being asked to repay at the Banks convenience that causes businesses problems.

    I any event Labours recent mad profligacy has just further increased the already out of control money supply so we are only a bit more doomed than previously. And of course you do not know whether or not there has been frank and open discussions between the Bank and the Government. Or do you?

  4. Kit
    Posted November 6, 2008 at 5:59 pm | Permalink

    No pleasing some people 😉

  5. no one
    Posted November 6, 2008 at 7:04 pm | Permalink

    Re "Jacqui Smith says public demand means people will be able to pre-register for an ID card within the next few months" she said: "I regularly have people coming up to me and saying they don't want to wait that long."

    Which people does she talk to? Thales and IBM by any chance?

    I cannot believe she genuinely thinks the public are behind this

    Talk about emperors new clothes

    Theres another 5 billion and counting you need to add onto the public overdraft

  6. Cassius
    Posted November 6, 2008 at 7:27 pm | Permalink

    The Times reports:

    "Yvette Cooper, Chief Secretary to the Treasury, has called on lenders to cut interest rates in line with Bank of England. Ms Cooper said: "The Government has stepped in to make the banking system safe, to support the banks. It is right now that the banks do their bit to support everybody else.”

    This suggests an answer to your question: "Have they been pressurised by the government acting through the Bank of England?"

  7. Adrian Peirson
    Posted November 6, 2008 at 7:43 pm | Permalink

    There is simply no need for Govt to Borrow money from the International Bankers.
    We could simply print it, it is only worthless paper.
    Why print Gilts, instead of Money.
    http://www.john-f-kennedy.net/executiveorder11110

  8. Peter
    Posted November 6, 2008 at 7:44 pm | Permalink

    Incomprehensible to me. Here am I, a prudent saver, without debt. As a result of the crash – caused by over borrowing by both consumers and banks – interest rates are reduced. Great – we bail out the unwise and penalise the thrifty. Now the return on my retirement savings (I am already retired, so it is cash) will be well below the rate of inflation – presently 5.2%. Maybe I should use cheap money to buy some assets. But I thought this was the scenario we were leaving behind. Does anyone know what is happening. I doubt it! Time for a resignation or two surely. Heads should roll. Unfortunately the Conservatives seem as much at sea as New Labour. Tories will rue the day they just echoed the ludicrous economic policy of the government.

  9. Brian Tomkinson
    Posted November 6, 2008 at 8:22 pm | Permalink

    Shares are down as the market senses panic at the Bank and I think you will find that sterling has now dropped further against the dollar. It seems clear to me that nobody, regardless of how many of them are intelligent economists, has a clue what to do.

    Banks, financiers and politicians have created this massive problem by activities which should be regarded as criminal and for which they should be prosecuted but nothing will be done. People who have been prudent and lived within their means now have to pay for this criminal irresponsibility. The moral of all this seems to be if you act recklessly, spend all you have and as much as you can borrow you don't need to worry because you will have enjoyed a lifestyle you could otherwise never have afforded and when it all ends in tears the state will look after you.

  10. mikestallard
    Posted November 6, 2008 at 8:39 pm | Permalink

    Today I went for a walk round Lynn, Norfolk. There was Connexions – an employment office for young people. I counted, in lunch hour, four people in the office, all of them employees of the government. Then, in the Fen Museum were another lot of three government employees. I was the only member of the public, I think. Our little centre for immigrants now has two full time employees, both on government pay.
    If only the government would just cut back a little on their reckless expenditure, instead of pretending that it all goes on "schools and hospitals and front line staff", perhaps the lending rate could drop safely and the result be passed on to the lenders through the banks.

  11. Mike Gill
    Posted November 6, 2008 at 9:10 pm | Permalink

    Dear Mr Redwood,

    Some thoughts on events

    Could the drastic MPC action be signaling a change in Government policy to clamp down on borrowing (I wish)? I have thought for some weeks that the Government is running very scared, and what statements we have had are inconsistent.

    I guess that the banks are not passing on rate reductions because they are desperate to earn their way out of huge damage to their loan and investment assets. This is simply a mechanism for transferring their losses to the general economy, with dire consequences. The banks simply cannot fulfil their role, and are rendering monetary policy sterile.

    What is needed is to establish, urgently, an alternative banking system for the consumer economy. The big supermarkets are in a position to do this with Treasury backing (supermarkets are cash-positive businesses as well)

    The traditional banks would then have to survive on existing loan interest if they could, or fail. A major Government commitment to depositors would be required, and protection for borrowers. Is this practical?

    All this is hopeless if the taxpayer has taken on the liabilities of the traditional banks!

  12. not an economist
    Posted November 6, 2008 at 10:08 pm | Permalink

    Don't the two polices contradict one another?

    On the one hand the central bank slashes interest rates to 3%.

    On the other hand, Govt will then have a massive bond issue to raise the funding it needs to cover bank bailouts, nationalisation and the consequences of a slowing economy. To get takers for this debt a decent interest rate has to be offered. But surely this will create an upward pressure on interest rates – at a simplistic level a govt bond may offer 5% while financial insitutions, as a consequence of the central bank base rate cut, will only be offering 3%. Such institutions may have no choice but to go it alone and set their own interest rate irrespective of the central bank's base rate.

    The govt could then take a more interventionist stance and force financial insts to stick more closely to the bank base rate. But then we would have a situation where banks would be unable to raise funds (e.g., savings) to fund the loans Central Government is so eager for them to make to the private sector. Indeed, unable to set an interest rate that would attract savers/investors the banks would presumably be unwilling to make more loans since that would make their balance sheets look particularly precarious which is the opposite of what the banks have been trying to do recently.

    This would be a crucial point in the process: the goverment could either take increasing control of the banking sector so as to try and overcome the contradictions I have mentioned so far or accept its running down the wrong road and change course – cut its borrowing, cancel the nationalisation of the banks and start looking again at the potential for public expenditure cut backs. Given what has happened recently and the enthusiasm with which the govt has nationalised some of our biggest banks, I honestly think they may take the first route.

    There is yet another option I haven't mentioned: If the govt can't raise funding thru borrowing, the BoE could simply do a Ben Bernanke and create the money for the borrowing out of thin air. But thats merely a diversion. That will generate price inflation which will be ofset by either increase govt intervention in the economy again (e.g., price/wage controls) or backtracking (e.g., reduce borrowing etc…,).

    I also wonder what signals this sudden dramatic rate cut sends to industry. If the BoE is panicking – as this move suggests – then what will happen to business confidence? This may inturn make it more and more difficult for the govt to sell its bonds which will inturn mean it will have to set the interest rate on them even higher (loop back to my fourth paragaph).

    But don't worry, 'cos Gordon tells us we are better prepared to tackle this recession than any other European Govt.

  13. Lola
    Posted November 6, 2008 at 10:14 pm | Permalink

    Peter posted-…"As a result of the crash – caused by over borrowing by both consumers and banks" …and government ,and government also taxing and spending capital.

  14. Vaughan
    Posted November 6, 2008 at 11:13 pm | Permalink

    Have I read somewhere that there is a by-election today?

  15. Deborah
    Posted November 6, 2008 at 11:59 pm | Permalink

    I don't understand. Why on earth would sterling go up today?

  16. David morris
    Posted November 7, 2008 at 12:28 am | Permalink

    Why now? Well obviously nothing at all to do with Glenrothes, even though electoral bribes were so successful in Crewe and Nantwich.

  17. StevenL
    Posted November 7, 2008 at 1:07 am | Permalink

    I was always under the impression that the DMO auctioned off gilts, effectively allowing the market to decide the actual interest rate.

  18. David C
    Posted November 7, 2008 at 1:57 am | Permalink

    What is all this repeated "inflation would fall again in 2009" message? It may be true of 2009, but it will rocket after that.

    How else will the government pay for the investment in bailing out banks but by printing the necessary money? How better to erode the burdens of debts, of its own, of the nation's companies, and of its voters, by letting inflation rip for a while? What will happen to the price of imported goods if the pound sags because it no longer offers attractive interest rates?

    I consider the bank has been doing me a great service by robustly defending me from these ills, which I fear much more than any recession.

  19. James
    Posted November 7, 2008 at 3:22 am | Permalink

    Totally agree with Peter. I too am a prudent saver only to see my real income decimated by the current rate reductions and the inflation tax. It has always been the way of governments to inflate their way out of economic crises but this is unprecedented. History shows that reducing interest rates and printing money leads to inflation. Maybe not this year but it's coming soon. I'm afraid that Blue Labour are no different than New Labour on this subject (unless you would like to correct me Mr Redwood). Nothing else for it but to ditch fiat currencies and buy assets that are actually worth something like gold or commodities. Jim Rogers commodity index (RJI) is a good example IMO.

  20. Tony Makara
    Posted November 7, 2008 at 8:30 am | Permalink

    Its clear that the MPC is in a glove-puppet relationship with the Labour government. The latest politically motivated cuts in rates are indeed dangerous and are indeed an attempt to play catch up. The move will be welcome relief for some but we have to focus on the wider picture. I believe all economic policy has to be based on maintaining price stability and ensuring that our currency is stable on the forex market. Without these two fundamentals nothing else can be achieved. Of course inflating the economy does help, for a while, but before long it undermines everything and we end up having to crank up interest rates again. We need stability. It was disappointing to see senior Conservatives supporting the MPC over this.

  21. Johnny Norfolk
    Posted November 7, 2008 at 9:27 am | Permalink

    We are on the tread mill to disaster. Labour just will not do what they will have to in the end. Will it need the IMF to do what we need as a condition of a bail out loan, as they did to the last Labour government. I think so.

  22. APL
    Posted November 7, 2008 at 10:28 am | Permalink

    Peter: "a prudent saver, without debt."

    Politicians today have no interest in prudence. They are having a fling with debt, they are reckless spendthrifts – it always helps that they spend someone else's money too.

    You might expect the Tory party to advance thrift and advocate a sound savings based economy. Since the Tory party under Cameron doesn't 'do' principles, advancing and defending such a policy is too much like hard work – god forbid they might actually do something worthwhile for the £120,000 + expenses p.a. that we pay them.

    Financially independent folk are too much trouble so much less amenable to being bossed around and far more independently minded for todays stupid politicians.

    Peter: "Now the return on my retirement savings.."

    Expect no assistance from the Tory party nor sympathy from Mr Redwood. He and all his chums in Parliament have a very comfortable tax funded indexed linked pension, he nor his retired political chums will not be feeling the pinch during their retirement!

    You have been recklessly sober in you financial arrangements. Should have run up huge debts, taken on multiple mortgages and massive credit card debts. Then the Tory party would come riding to your rescue with someone else's money – probably your son's, daughters or grandchildrens future earnings.

    Reply: An MP's salary is £63,000, not £120,000. The whoel point of my blog advice is to rescue the economy dfrom a disastrous crash. Savers will not benefit from the crash. I am all in favour of prudence. The last year has seen billions wiped off savers' assets thanks to the poor management of the economy.There is a betetr way.

    • APL
      Posted November 8, 2008 at 12:58 pm | Permalink

      JR: "An MP’s salary is £63,000, not £120,000. "

      Based on returns we have seen so far; allowing (collectively) the EU to do your work (badly) for you, for the Tory party spending the last ten years squabbling among yourselves instead of building a coherent abiding policy to present to and inspire voters, and consequently allowing the EU dominated British government to ruin the British economy, based on those things, £63,000 is about £40,000 too much.

      JR: "The whole point of my blog advice is to rescue the economy dfrom a disastrous crash."

      Good luck, the crash is upon us. We should now be planning not how to put it off, but how to build a better stronger economy afterward. You seem to want a debt based economy – essentially to carry on as before. But this is an opportunity to encourage … prudence. Not in the dishonest fraudulent way Gordon Brown used to use the term, but a real savings based wealth generating economy.

      The Tory party ought to be encouraging people like Peter, If a Tory front bench politician came out and said, 'Yes, put your savings in the bank, you will get interest on it tax free, we the Tory government will control inflation and government spending, and that will allow us to abolish inheritance tax and bring down Government debt over the longer term. We will role back the interference of the state in your affairs, cut back on meddling inspectors, reinforce the principle of private property. We will build a business friendly tax regime to encourage employment. The BBC will be made an independent self financing organization free from Government interference both foreign and domestic."

      The last bit about the BBC was tagged on because a) it needs to be done, but b) because without reigning in the BBC, none of the other things can be accomplished.

      For gods sake, someone in the Tory party stand up and set the agenda. Otherwise, what collectively are you for?

  23. rugfish
    Posted November 8, 2008 at 10:37 am | Permalink

    The Bank of England has cut interest rates by a massive 1.5% in a tactic to trigger spending, but as we've seen already, this tact did not work in America.

    Cutting interest rates will have little or no impact on the economy.

    Yes, if cuts are passed on to those on variable rates, or to new borrowers who are keen to risk taking a mortgage in volatile times with jobs evaporating rapidly, then it may help to reduce payments for some, but it won't help the millions of borrowers on fixed rates nor will it help the remortgage market or those planning to retire on equity release schemes.

    In addition to falling property values, lenders have reduced their loans to value ratio's and increased income ratio's for borrowers. Also, many non-conforming lenders have already sold up, moved on and are left the scene or are unable to sell their mortgage portfolio's and will consequently be unable to lend because they have no proper balance sheet.

    Northern Rock's previous business model has now been taken out of the equation, and the washes of money it was once producing has been removed from our economy. In 2007 for instance, NR's remortgage business accounted for 20% of all remortgages with non-conforming lenders accounting for a further 20% and this lending is an irreplaceable drop of 40% not counting HBOS which accounted for most other lending which is now itself unable to lend or survive for the very same reasons.

    The markets are not buying their portfolio's and this happened well before Lehman Bros dropped off the edge of its own financial earth.

    A reduction in interest rates amounts to tinkering and blind panic.
    It also underscores a fundamental lack of understanding by the government and Bank of England of how much the remortgage market once fueled our economy and attempts to revive it is akin to trying to re-create the already burst bubble.

    Item:
    How will a firm which needs to give a bank an asset guarantee manage to borrow against a home which has devalued when its current obligation exceeds the banks new risk ratios?

    Item:
    How will a home owner remortgage their devalued home when their lender has lowered the loan to value ratio in a falling market?

    Item:
    Where is the missing money in our economy going to come from when the remortgage market has dried up and is under the bureaucratic thumb of the FSA with its stringently enforced rules and regulations which themselves undermine the market?

    Jobs can be saved by relaxing and remodelling mortgage regulation to remove red tape along with costs to business.

    Additionally, lending ratio's and access to unsecured loans should be made available to businesses either through the banking institutions or through the DTI.

    However this would simply perpetuate the reality that we are as an economy, spending money which has previously appeared from thin air which once propelled business and an economy which is without a real manufacturing base within a global economy which has itself dried up and hopefully awoken to the reality that the money driving it forward never really existed in the first place except mostly for the remortgage market and your flexible friend.

    There's no turning back to this and it would make no sense to try for the world has finally caught on to the reality that nothing can be created from thin air and borrowing money on illiquid or devaluing assets is just not good practice and likely very potty.

  • 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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