A widely-held, but erroneous, view is that low interest rates act invariably as a welcome, unambiguous boost to business, consumers and the economy. Nonetheless, it seems almost incredible that the Bank of England has maintained an emergency rate since March 2009.
The granting of (notional) independence over monetary policy to this institution has allowed politicians to place this central role in economic decision-making beyond electoral accountability. Indeed for the past eight years, ultra-loose monetary policy has been deliberately adopted in preference to expansive fiscal policy on tax and spending. Now that Chancellor Hammond has his feet firmly under the table it will be interesting to see whether his Autumn Statement heralds a reappraisal of these policy preferences.
In truth for so long as the UK economy remains on the life support of low rates through an implicit pact between Treasury and the Bank, it is difficult to see how the UK economy will move towards balanced, sustainable recovery. For virtually every Briton under the age of thirty, the notion of near zero interest rates, and the commensurate distortion to the pricing of risk and asset values that results, is the new normal.
Make no mistake – ultra-low interest rates for such a prolonged period have potentially dangerous distorting economic outcomes. By destroying returns for savers, excessively prolonged loose monetary policy has helped discourage the availability of funds for productive investment. Today’s defined-benefit pension schemes are almost all in substantial deficit. This necessitates ever higher corporate contributions to pension funds – further reducing available funds from profits made for future growth.
Paradoxically it is the poor who lose out most from near-zero rates since the least well off have not reaped the lottery-type gains that have landed in the lap of property owners. It is estimated that house prices are around twenty per cent higher (considerably more in London and the South East) than would have been the case had ‘normal’ interest rates applied. Since the financial crisis homeowners have been amongst the most conspicuous winners; meanwhile clambering onto the housing ladder has become ever more of a pipedream for the vast majority of young Britons, who have also been hard hit by ever rising rents. It is precious wonder that a sense of political division has resulted.
History teaches us that policies designed to insulate from short-term shock often come with anticipated longer-term consequences. The impact of the 1930s global Depression was cushioned by restrictive practices and cartels in British industry. Tariff reform then, in an era of protectionism, saw the UK economy move from global free trade towards a policy of Imperial preference – our captive Empire markets featherbedded UK business during the 1930s slump, but did lasting damage to our longer-term competitiveness, as became apparent after the Second World War.
Today the prolonged stimulus of cheap credit favours short-term investment which produces weaker growth. Persisting with near-zero rates of interest has also retarded the essential cleansing mechanism of capitalism. Countless zombie companies remain in existence as lending banks have no incentive to pull the plug on non-performers, and the tying up of capital and labour in non-productive activity has engendered a false sense of security, boosting short-term employment levels. However, the diminished productivity augurs ill in the teeth of fierce global competition in the years ahead.
With hindsight it is arguable that the Bank of England’s decision in August to reduce rates further to 0.25 per cent was a premature overreaction to the EU referendum result. Nevertheless, there remains chatter in the financial markets that the Bank of England may yet follow the Swiss, Danes, Swedes and Japanese in implementing negative interest rates. This would be a calamitous mistake.
The very concept of having to pay a bank for the privilege of depositing cash with it seems totally at odds with the fundamentals of everyday commercial reality. There is also negligible evidence that consumption will be boosted by penalising those who put savings aside. Indeed the more likely impact of setting a negative rate of interest would be panicked saving – this has been the experience in Japan, where this autumn the central bank has instead targeted interest rate yields on ten year government bonds in order to provide certainty for long-term infrastructure investment. A similar approach to future tranches of quantitative easing here in the UK might help provide a timely fiscal boost to kick-start major infrastructure projects.
Once institutional investors in gilts are required to pay governments for the privilege of lending to them, watch as pension funds who constantly need to meet market obligations turn to pumping money into ever riskier asset classes. We all know where this will eventually lead – yet another cycle of boom and bust. It really is not different this time – a sustainable recovery requires a normalcy in the cost of credit rather than persisting with a reckless mispricing of risk. If markets start losing faith in the conduct of the central bank, government needs to step in with a sensible level of fiscal stimulus. This is the backdrop to what lies at the heart of critical decisions within this week’s Autumn Statement.