There are many economic myths around. There is the idea that the government abolished boom and bust. There is Labour latest fashion that borrowing and spending more in the public sector produces a stronger recovery. So far the biggest borrowing nation of all the major economies, the UK, is the only one not to have pulled out of recession. My favourite today is that we have record low rates of interest which will see us through the crisis.
It is true that the Bank of England’s MPC has set 0.5% as the interest rate. The problem is the markets don’t think that is a realistic rate for normal commercial transactions, so it does not operate in the private sector.
If you want a mortgage and are lucky enough to be able to get one, you will be paying 4-5%. That’s eight to ten times the Bank’s low base rate – not just the odd 1% over to allow the Building Society a profit.
If you are a small business wanting to borrow, you will be paying 7-15% for an overdraft if you can secure one. That’s fourteen to thirty times base rate.
If you are a large business wanting to borrow from the corporate bond market you will be paying between 6% and say 10% depending on your balance sheet and trading strength. That’s twelve to twenty times base rate.
And if you are the government wanting to borrrow for ten or more years you will be paying 4% to 4.5%, or eight to nine times Base rate.
So what’s the point of Base rate? It gives the MPC something to do to set it and to justify their large salaries. It does have two impacts on the economy. It does allow the government to borrow for the short term at a lower rate. So far markets have gone along with lending for a few months or even a year or two to the government at low rates related to the base rate. Recent weeks have seen increases in the rates they charge the government for anything other than the short term.
It also helps the broken banks make a small fortune. All the time they can borrow short in the money markets and with government help at rates related to Base rate, and lend longer at rates totally unconnected to base rate, they can make more money. Given the way the banks are regulated, with the regulators shutting the stable door after the horse of excess credit has bolted, that does not help the rest of the economy as much as we would like.
UK official rates are too low for the state of the public finances.They are also largely irrelevant to the state of the non bank economy, as no-one can borrow at anything like them.