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| Why has the Bank of England increased interest rates? It ran out of options | Why has the Bank of England increased interest rates? It ran out of options |
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| Thu 2 Nov 2017 13.49 GMT | |
| Last modified on Fri 3 Nov 2017 11.41 GMT | |
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| The 0.25% rate rise announced this morning is not a normal interest rate rise. But that is because we are living through abnormal economic times. | The 0.25% rate rise announced this morning is not a normal interest rate rise. But that is because we are living through abnormal economic times. |
| Usually the Bank of England would raise interest rates when the economy was beginning to “overheat” – that is, when consumer and business demand was accelerating. But no one could say the economy was overheating today. | Usually the Bank of England would raise interest rates when the economy was beginning to “overheat” – that is, when consumer and business demand was accelerating. But no one could say the economy was overheating today. |
| Yes, we have high employment levels (though they disguise quite a high level of underemployment: people who would like to work longer hours than they do). In most all other respects, however, the economy is performing very poorly. Productivity has remained stalled since the financial crisis – and is well under that of our major competitors. | Yes, we have high employment levels (though they disguise quite a high level of underemployment: people who would like to work longer hours than they do). In most all other respects, however, the economy is performing very poorly. Productivity has remained stalled since the financial crisis – and is well under that of our major competitors. |
| Business investment is flatlining. We have a large and persistent trade deficit. And most of all, real earnings (after inflation) are in decline. Most people have barely had a real pay rise since 2005 – and the forecasts suggest they will not do so for a few years yet. We are experiencing the longest period of wages stagnation for 150 years. | Business investment is flatlining. We have a large and persistent trade deficit. And most of all, real earnings (after inflation) are in decline. Most people have barely had a real pay rise since 2005 – and the forecasts suggest they will not do so for a few years yet. We are experiencing the longest period of wages stagnation for 150 years. |
| Lenders have already bumped up the cost of fixed rate mortgages ahead of the Bank of England’s decision to raise base rate from 0.25% to 0.5%, and mortgage borrowers on tracker and variable rates will see their monthly payments become more expensive in the coming days. | Lenders have already bumped up the cost of fixed rate mortgages ahead of the Bank of England’s decision to raise base rate from 0.25% to 0.5%, and mortgage borrowers on tracker and variable rates will see their monthly payments become more expensive in the coming days. |
| Savers will gain as banks and building societies improve the rates available on deposit and Isa accounts, although increases are unlikely to come for several weeks. | Savers will gain as banks and building societies improve the rates available on deposit and Isa accounts, although increases are unlikely to come for several weeks. |
| How much consumers and businesses cut back on spending and investment in the face of higher rates will depend on signals from the Bank about the trend for future increases. | How much consumers and businesses cut back on spending and investment in the face of higher rates will depend on signals from the Bank about the trend for future increases. |
| So why has the Bank raised the interest rate? Because its legal mandate is to hold inflation to 2%, and the rate has now hit 3%. The Bank only has one tool, and it has used it. But the reason for higher inflation is almost entirely due to the devaluation of the pound that has occurred since the vote to leave the EU last year. And this in turn is making us all poorer, cutting further into real wages. So really the last thing the economy needs is for further demand to be sucked out of the economy by a rise in interest rates. | So why has the Bank raised the interest rate? Because its legal mandate is to hold inflation to 2%, and the rate has now hit 3%. The Bank only has one tool, and it has used it. But the reason for higher inflation is almost entirely due to the devaluation of the pound that has occurred since the vote to leave the EU last year. And this in turn is making us all poorer, cutting further into real wages. So really the last thing the economy needs is for further demand to be sucked out of the economy by a rise in interest rates. |
| The rise will particularly hurt those with mortgages and consumer debts who will now have to pay more. Though the rise is small, it will increase the risk of debt defaults and of some households falling into negative equity. | The rise will particularly hurt those with mortgages and consumer debts who will now have to pay more. Though the rise is small, it will increase the risk of debt defaults and of some households falling into negative equity. |
| But in many ways the Bank of England is not really to blame here. It has a legal mandate and it is exercising it. The problem really lies with the government, whose continued programme of fiscal austerity is the reason why the UK economy is still suffering from deficient demand eight years after the financial crisis. During this period businesses have been paying down their debts and holding off from investment because of the uncertain economic situation – particularly over the past year, since the Brexit vote. | But in many ways the Bank of England is not really to blame here. It has a legal mandate and it is exercising it. The problem really lies with the government, whose continued programme of fiscal austerity is the reason why the UK economy is still suffering from deficient demand eight years after the financial crisis. During this period businesses have been paying down their debts and holding off from investment because of the uncertain economic situation – particularly over the past year, since the Brexit vote. |
| At the same time global demand has been relatively weak. Households have been borrowing – but are now doing so unsustainably, as the Bank has separately warned. So what was really needed in this period was government investment. But government investment, as well as current spending, has in fact been deeply cut until this year. | At the same time global demand has been relatively weak. Households have been borrowing – but are now doing so unsustainably, as the Bank has separately warned. So what was really needed in this period was government investment. But government investment, as well as current spending, has in fact been deeply cut until this year. |
| In this sense the past seven years have been a huge missed opportunity. We have had negative interest rates throughout this period. These should have been used by the government to borrow for investment in infrastructure and innovation. This would have stimulated demand in the short term and stronger economic growth in the long. | In this sense the past seven years have been a huge missed opportunity. We have had negative interest rates throughout this period. These should have been used by the government to borrow for investment in infrastructure and innovation. This would have stimulated demand in the short term and stronger economic growth in the long. |
| But it is not too late for this. At its new rate of 0.5%, the interest remains at a historically very low level: with inflation at 3% the government can still borrow at negative cost. So this is what the chancellor should do in his budget later this month. | But it is not too late for this. At its new rate of 0.5%, the interest remains at a historically very low level: with inflation at 3% the government can still borrow at negative cost. So this is what the chancellor should do in his budget later this month. |
| And then we need to look again at the bigger issue here, which is the relationship between fiscal and monetary policy. Over the past eight years the government’s austerity programme has left the Bank of England having to do all the work to keep demand up and the economy moving. But it has run out of road. Interest rates could go no lower, and its programme of quantitative easing has been only partially effective at best, with a deeply unequal distributional impacts. (It has raised the price of assets which are largely held by the rich.) It is time to restore the proper role of fiscal policy in managing the economy. If the Bank of England has done anything, it has told us that. | And then we need to look again at the bigger issue here, which is the relationship between fiscal and monetary policy. Over the past eight years the government’s austerity programme has left the Bank of England having to do all the work to keep demand up and the economy moving. But it has run out of road. Interest rates could go no lower, and its programme of quantitative easing has been only partially effective at best, with a deeply unequal distributional impacts. (It has raised the price of assets which are largely held by the rich.) It is time to restore the proper role of fiscal policy in managing the economy. If the Bank of England has done anything, it has told us that. |
| • Michael Jacobs is director of the Institute for Public Policy Research’s commission on economic justice | • Michael Jacobs is director of the Institute for Public Policy Research’s commission on economic justice |
| Interest rates | |
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| Bank of England | |
| Austerity | |
| Economics | |
| Economic growth (GDP) | |
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