The need for a rethink by the Central Banks

The Fed, the Bank of England and some other leading Central Banks set interest rates based on the idea that if unemployment falls too far there will be inflationary pressures on wages. This requires them to put up interest rates and deter more credit being advanced, to reduce the pressure of excess demand in the economy.

In the last century it was the case that the USA, UK and other leading economies were prone to wage inflation when potential demanded exceeded potential supply and when unemployment fell to a low level. The so called Phillips curve illustrated this trade off. Whilst there were monetarist economists who preferred a money based explanation of inflation, and other economists who pointed to the role of external shocks and commodity price trends in inflation, the mainstream view based on capacity and employment was bedded into the forecasts and intellectual framework for rate setting.

I have long queried the idea of national capacity linked only to employment in an increasingly global market. We have seen how economies capable of creating many jobs and expanding capacity invite in large amounts of migrant labour, as in the USA, UK and Germany, reducing the upwards pressures on wages. We have seen how the US and UK simply import a lot more goods and services when their domestic capacity is insufficient to meet demand, tapping into vast numbers of unemployed and underemployed people elsewhere in the world capable of doing the work. There is also the option of putting more capital to work with labour saving investment.

The Governor of the Bank of England has acknowledged this in a speech which said the Phillips curve is now very flat – in other words there is not much of an inflation threat from low official unemployment figures. The Fed has recently announced a major rethink of its approach, and has stated that in the USA now the curve is also fairly flat. In the USA employment rates are still low at a stated 60.6% of the working age population, and as the economy improves more people find work who were not registered as unemployed. There are also strong migrant flows into the country to take up new jobs. Low unemployment is not a good guide to wage growth.

So what is a better guide for a Central Bank seeking to set rates? I prefer them to consider money figures more, where the figures show too much tightness in the UK and a modest rate of expansion in the USA that should not lead to an unsustainable rise in inflation. Of course they need to listen to markets and watch the trends in output and prices generally as important guides as well. The markets saved us from too much tightening in the USA late last year. What will it take for the UK authorities to follow a more pro growth policy? Given the strict fiscal squeeze, there is an even better case for a looser money policy in the UK. The US is lightening up the money supply even though the government has embarked on a big fiscal relaxation as well.


  1. Mark B
    April 13, 2019

    Good morning.

    We have seen how economies capable of creating many jobs and expanding capacity invite in large amounts of migrant labour, as in the USA, UK and Germany, reducing the upwards pressures on wages.

    What has happened is that big business has demanded a evermore supply of cheap labour to keep wages low and thereby wage inflation and interest rates. This has indeed been very good for them but has led to many social pressures on services and people. Transport to and from work takes longer and is more crowded. Getting to see a doctor harder. Places for schools equally so and so on. We have, as been described elsewhere, privatised the benefits and socialised the downsides.

    And with people taking less

  2. Steve Reay
    April 13, 2019

    It’s simply unfair to savers to have rates set below the inflation rate, commonly known as grand theft.

    1. Dominic Johnson
      April 13, 2019

      Why should one group be guaranteed profit no matter what?

      1. Caterpillar
        April 13, 2019

        Dominic Johnson,

        The that (Y-C)/Y is too low. Insufficient resources flow to investment (infrastructure, capital, training & education). Non-floating interest rates break the link between saving and investment.

        There are alternatives through a changed tax system (such as expenditure based taxes replacing income based, wealth based, and cash flow minus investment).

      2. anon
        April 13, 2019

        If you could define profit you may find an answer.

        One should not have their purchasing power stolen by government effectively creating fiat or allowing banks to create it and then bail them out.

        All groups are effected make no mistake. Initially each group differently but when capital is inflated away along with debt. You effectively ensure the remaining workers carry the can.

        Those who are closest to the money creation win, that would be the connected and megacorp.

        Taxation and creation of money given to all individuals is the way to stimulate economies rather than to specific bailouts.

        Why give money to one group banks, and debtor s via inflation?

        1. eeyore
          April 13, 2019

          One might add that it is bad social policy to penalise prudence and self-reliance while simultaneously encouraging irresponsibility.

    2. Mike Stallard
      April 13, 2019

      Yes but the government is the biggest borrower. So they want to keep the rate of borrowing as low as possible. We are approaching £3 trillion of debt remember. We owe about as much as the GDP.

    3. Mike Wilson
      April 13, 2019

      Unfair? Interesting concept. So it is fair that someone who has saved some money must be able to increase their savings, presumably at no risk, by lending the money to someone else. Why do you think that? The logical extension of that is that some people own all the money and others have only debt.

    4. Mike Wilson
      April 13, 2019

      No-one is forcing you to save. Government wants you to spend ALL your money and buy endless consumer tat – to keep the economic balls in the air. Be a good citizen. Spend every penny you have.

      Better! Do as Mr. Redwood prescribes and borrow money to keep buying new cars to help ‘our car industry’.

  3. agricola
    April 13, 2019

    Interesting for a layman in these financial machinations. Whether uncontrolled as now or controlled in the future we have the tool of immigration to keep a reasonable control of wages.

    Importing cheaper product from low cost sources is fine tactically but questionable stategically. Automation, robotics and AI will provide the means to do it ourselves because the human element will be creation not labour. Fusion Energy will provide the final win win scenario. Just make sure we ring fence it from foreign involvement. Too much of our technology has been sold on the cheap in the past and put outside our control. Globalisation is the tool large corporation have used to circumvent the inconvenience of government.

    The banks having robbed the nation to cover their own failings, with low to none existent rates for savers but usuary rates for borrowers need to be brought to heel with real competition. However this will not please the establishment so will be difficult to rectify under the present government/banking relationship where they are both in hock to each other. Perbaps a professional Brexit Party have better ideas.

  4. Lifelogic
    April 13, 2019

    Indeed some relaxation is needed. But also relax the damaging fiscal squeeze with the highest, most complex and generally idiotic taxes for nearly 70 years and cut out all the endless government waste. Just firing Hammond and May would be a huge boost to confidence for the country. Also sort out the lack of competition in banking that lets the banks get away with paying .03% or similar on deposits while charging 4% to 68% plus on lending (even to rather sounder borrowers than the banks). Certainly the government regulatory interference and micro managing of bank lending is totally misguided and is doing huge harm.

    High taxes are hugely damaging to productivity. They divert people from productive activity to tax planning, force companies to use over complex expensive structures, they push businesses and people overseas and when the government do get the money they largely waste it anyway. Much is clearly spend actually doing positive harm. Also creating often dire, second rate virtual monopolies and unfair competition – as we see in health care, social housing, private housing restrictions that force some buyers to subsidise others, in schools, the many joke university courses, transport, the idiot energy structures, the many mad “renewable” subsidies and much else.

    It seems Hammond has deliberately set against growth perhaps to try to show his project fear lunacy was coming true. Remove this economic illiterate, remainer, anti-democrat, PPE dope and pusher of project fear please. He is clearly, as best, hugely misguided at worst an appalling traitor who will give us Corbyn/SNP and even higher taxes than Hammond.

    1. Mike Wilson
      April 13, 2019

      You didn’t mention ‘green crap’ once. You are slipping! Lots of accounts paying 1.5% with instant access. Plenty of mortgages at 2%

      Credit card debt and unsecured loans, one has to agree with you. In a competitive market, why is there no new challenger providing credit cards with an interest rate of say 7%. They could pay investors 5% and still make a fortune. Especially as there is a transaction fee to cover costs.

  5. Lifelogic
    April 13, 2019

    More total drivel from Philip Hammond:-

    The UK has got “a bit of work to do to recover our reputation as cool, calm and collected”, Mr Hammond told Bloomberg at the International Monetary Fund’s spring meeting in Washington DC.
    He intends to launch a three-year spending review later this year to plan overall government spending levels. It was part of a scheme to “end austerity” and increase spending across large swathes of Government which have had to exercise restraint in recent years.
    However, if there was still no conclusion to the Brexit plans then the process might have to be cut short, Mr Hammond said. “If we don’t have a deal done, the level of uncertainty that will remain probably makes it inappropriate to do a long-term spending review,” he said.

    The last thing we need is increased spending and waste by government! They waste nearly 50% of GDP already.

    1. Dominic
      April 13, 2019

      Yes, you note how Hammond uses the role of State spending of taxpayers money to achieve a political outcome.

      I always believed that State spending was to be used to finance essential public services. How naive I have been. I didn’t take into consideration the Machiavellian tendencies of the modern political class that they would take the liquidity afforded to them by the taxpayer to finance their political ambitions

      We must take back control from May, Hammond and their ilk.

    2. Caterpillar
      April 13, 2019


      Government expenditure is 38% of National Income. About 27% of that is transfer payments (including state pensions) so that spending is still directed by ‘the people’.

      That said, I have approximately zero confidence in any spending review led by the current Chancellor.

    3. Mike Wilson
      April 13, 2019

      It does make one wonder why people in an audience don’t just laugh at Hammond.

  6. Dominic
    April 13, 2019

    You afford the influence of central banks and their role of setting interest rates policy far too much credence. There are greater forces at work in an economy and the actions of central banks on the behaviour of individuals and companies in the real world are meaningless.

    It is this obsessive Keynesian desire for control that has assisted in developing such a restrictive mindset and a culture that embraces the idea that controlling the economic behaviour of all is a policy in itself

    Just leave businesses and individuals alone. They are not sheep to be herded. They are not economic or political capital to be nurtured. Thatcher slashed taxes and the left hated her for it. Why? Because tax cuts reduces the flow of monies to the State and thereby reduces the State’s power to control our economic life. Greater State spending is of course spending taken by political players with the prime function of generating political goodwill and loyalty. Tax cuts negates that important political function

    What is needed in the UK is absolute reform of the State to cuts its ability to manipulate, more competition, lower direct and lower indirect taxes, less onerous demands on business from this socialist PM

    We need a complete culture change, again as we saw in 1979. What we now have plays into the hands of Marxist Labour in which state control as again become the norm. That’s dangerous as economic control usually morphs into social control as well

  7. David Maples
    April 13, 2019

    Yes, but we don’t want to risk UK monetary expansion being used to prop up debt ridden euro countries eg France, whose quantitative easing programme was halted by the Bundesbank. If this were to happen, our output would be held back, while the ridiculous and unsustainable euro would be given yet more life support!

    1. Mike Wilson
      April 13, 2019

      Err, aren’t we very much a debt ridden country?

  8. Arnie from Newington
    April 13, 2019

    When the Governor of the Bank of England starts talking about the Philips Curve it’s time to batten down the hatches and prepare for recession.

  9. Nigl
    April 13, 2019

    Civil servants, risk averse not business orientated, probably can’t be fired and get a boiler plated index linked pension when they retire.

  10. Stred
    April 13, 2019

    It would assist the car industry and the economy if the government stopped green gestures to ban internal combustion engines before it has the infrastructure or any plan for enough reliable generation of electricity for electric vehicles or heating. The improvement in air quality can be achieved using filters and adblue. CO2 reduction is more effective by building nuclear, which is needed for electric transport anyway.

  11. Derek Henry
    April 14, 2019

    Finally the penny has started to drop.

    I’ve only been telling you for 2 years that MMT economists are the only ones who have it right but you wouldn’t listen. Even the chief economist of Goldman Sachs says Warren Mosler has it right.

    If the Central bank increases the cost of lending then businesses just pass that increase on as higher prices to consumers that pushes inflation higher.

    After two decades of 0 rate policies the yen remained problematically strong and inflation problematically low. And the same holds for the euro today

    There is another aspect to the foreign exchange channel, interest rates, and inflation. The spot and forward price for a non perishable commodity imply all storage costs, including interest expense. Therefore, with a permanent zero-rate policy, and assuming no other storage costs, the spot price of a commodity and its price for delivery any time in the future is the same. However, if rates were, say, 10%, the price of those commodities for delivery in the future would be 10% (annualized) higher. That is, a 10% rate implies a 10% continuous increase in prices, which is the textbook definition of inflation! It is the term structure of risk free rates itself that mirrors a term structure of prices which feeds into both the costs of production as well as the ability to pre-sell at higher prices, thereby establishing, by definition = inflation.

    I’ve also told you over the last 2 years taxes don’t fund government spending because governments have to spend first and then collect taxes from that spending but you just won’t listen. Even the Romans knew they had to spend the coins into the economy first before anybody could use the coins to pay their taxes.

    Imagine if after brexit and we win and become truely independent and we decided to launch a new currency called the Crown. The treasury said okay pay your taxes and give us your Crown’s so we can spend. Nobody has any Crown’s because the government wouldn’t have issued them yet. Or they said we are going to borrow some Crown’s so we can spend. Who would they borrow them off and they have not been issued yet ?

    Not to mention the fact that government borrowing is not like a household and is infact a monetary operation and not a fiscal one. All it is, is a reserve drain so the BOE can hit its overnight interest rate.

    Fiscal Conservatives have had it wrong for nearly 50 years. Upside down and back to front brainwashed to believe the monopoly issuer of the £ operates like a household budget.

  12. Derek Henry
    April 14, 2019

    If after brexit the UK government had a spending review

    Put £900bn into the UK economy via government spending using an index finger and a computer keyboard and just credited bank accounts of workers, small and medium and large businesses.

    Then Decided to slash taxes right across the board which this country needs.

    Only took £200bn out of the UK economy via taxes from that £900bn spending then the UK government would be running a £700bn deficit.

    Well so what because what that actually means is that the private sector is running a £700bn surplus.

    The govt budget deficit = the private sector surplus to the penny.

    Trump knows this of course which is why he introduced a $trillion budget deficit in the US because he knew it created $trillion surplus in the private sector.

    Unfortunately, he gave most of that $trillion to people who didn’t need it but he was clever enough to at least know how it works.

    Reply If you create too much money you will experience a nasty inflation

  13. Derek Henry
    April 14, 2019

    The real question to ask John which it seems you are coming to round to in your post after thinking about what I’ve been saying for 2 years is.

    If the UK private sector has a £700bn Surplus when the govt runs a £700bn deficit will it cause inflation?

    That’s all that matters. Will the size of the private sector surplus we propose cause inflation?

    However, unfortunately there are no models out there to predict that because the fiscal conservatives over the last 50 years have been looking at it from the wrong point of view.

    The BOE and HM Treasury should have replaced the non sensical models they use looking at a budget constraint decades ago and replaced their models with an inflation constraint model. Then they would have an answer to that question.

  14. ferdinand
    April 14, 2019

    At school Inflation was explained to me by MV=PT. Changing the value of any one component affects the monetary system. There are many modern fanciful explanations and algorithms for inflation that provide jobs for budding economists. The price of money is surely the soundest mechanism.

  15. BR
    April 14, 2019

    Economics is a nascent ‘science’ with proponents of all the major 3 ‘philosophies’: Marx, Smith and Keynes. They are each very different from the others, yet none can be proved is disproved.

    There is another group of economists who believe in targeting zero growth (and therefore zero inflation). This avoids creating mountains of money that need more places to live/invest.

    When we look at the measures used in economics and the understanding of those who use them, we are in a sorry state. For example, they use partial measures of productivity such as GDP and believe that means that British workers are not working as hard as those of other countries. This is nonsense – the amount of tax paid does not have a direct relationship to the economic output of the people concerned (for that we would need to use a total measure of productivity) and yet even people in so-called ‘think tanks’ who are investigating these matters continually commit the same basic errors in understanding (there was an article on ConHome a while back doing exactly that).

    More research into economics is needed, there are too many people who are happy with its current state (despite not understanding it very well) when there is clearly more to know.

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