Do The Mpc Really Control Interest Rates?

[jpidding]

I've often wondered how this works? Surely it's just a matter of supply and demand. For every borrower there must be a saver. If the interest rate falls I might consider moving my savings somewhere else. This will create a distortion.

I believe that we are currently seeing a situation where the free market forces are working despite what the MPC tries to do.

We are hearing that lenders are not passing on the full 0.25% cut that we had in Aug. At the same time HSBC have just told me that they've raised the IR on my online saver account to 4.75%. Actually I'm gonna dump the lot into a Cahoot account that I've just opened which offers 5.25%.

LIBOR for 3 months is 4.59% (set this morning). This is the wholesale rate that banks lend to each other. Now if there is indded a (relatively) unlimited supply of money at 4.59% available to the banks, then why the hell will Cahoot offer me 5.25%. Yes, there has to be some fat in there to account for default risk (Cahoot and hence Abbey going bust), but I'm sure this is already taken into account and Abbey could borrow very close to (if not at) 4.59%.

ISA's offer 5% best case (Halifax).

Try to get a secured loan and the best you will find is about 6%. As shown, I can get 5.25%. Most mortgages seem to revert to a variable rate of between 5.5% and 6.5% once discounts/fixes expire.

Are we therefore seeing that the real rate at which we are lending/borrowing is a mid market of around 5.5%.

[MarkG]

For every borrower there must be a saver.

Uh, no. That may be how banks used to work, but not anymore.

[Guest Riser]

Suggest you look up "Fiat money" or "fractional reserve banking" on google.

Bottom line as I understand it is the banks can lend out around £90 for every £10 deposited so can get 9x the interest in than they give out, nice work if you can get it. The more people borrow, the more Fiat money gets generated in the economy, my understanding is that there is around 11% more sterling in the system now than just last year.

Its a scam but it appears to be how modern economies work, the only question is how long can it go on as it depends on the public taking on more debt.

[jpidding]

Suggest you look up "Fiat money" or "fractional reserve banking" on google.

Bottom line as I understand it is the banks can lend out around £90 for every £10 deposited so can get 9x the interest in than they give out, nice work if you can get it. The more people borrow, the more Fiat money gets generated in the economy, my understanding is that there is around 11% more sterling in the system now than just last year.

Its a scam but it appears to be how modern economies work, the only question is how long can it go on as it depends on the public taking on more debt.

I know all about the above. The theory is that person A puts £100 in the bank. The bank lends it to person B, who buys something from person C. Person C then deposites the money in the bank. The bank then lends it out to person D....an so on. There was only ever £100 in the system, but both A and C think they have £100.

BUT, there was still an equal number of lenders and depositers. A&C and B&D. The bank cant lend from TOTAL thin air....it has to have a doposite from somewhere, be it retail customers or wholesale lenders (other banks).

If people stop depositing because interest rates are too low then no more can be lent.

What the BOE does is to bring foreign money in by issuing bonds. They then lend this to the banks and the money supply goes up (lower interest rates). If, however foreign sources decide they dont want to invest in Sterling the BOE cant do this.

Its all about risk and sentiment. At the end of the day free market forces take over.

Edited October 5, 2005 by jpidding

[AteMoose]

I know all about the above. The theory is that person A puts £100 in the bank. The bank lends it to person B, who buys something from person C. Person C then deposites the money in the bank. The bank then lends it out to person D....an so on. There was only ever £100 in the system, but both A and C think they have £100.

BUT, there was still an equal number of lenders and depositers. A&C and B&D. The bank cant lend from TOTAL thin air....it has to have a doposite from somewhere, be it retail customers or wholesale lenders (other banks).

If people stop depositing because interest rates are too low then no more can be lent.

What the BOE does is to bring foreign money in by issuing bonds. They then lend this to the banks and the money supply goes up (lower interest rates). If, however foreign sources decide they dont want to invest in Sterling the BOE cant do this.

Its all about risk and sentiment. At the end of the day free market forces take over.

Nope.... I dont believe this is right

Correct me if im wrong but theory goes 10 people A1 to A10 all put £10 into a bank, £100 in total, the bank can now loan £1000 out to other customers. The bank creates £900 out of nothing and gives it to other people because it has £100 in the bank...

Edited October 5, 2005 by moosetea

[BuyingBear]

Nope.... I dont believe this is right

Correct me if im wrong but theory goes 10 people A1 to A10 all put £10 into a bank, £100 in total, the bank can now loan £1000 out to other customers. The bank creates £900 out of nothing and gives it to other people because it has £100 in the bank...

A. Deposits £10 in bank.

Bank can then lend £100 to B.

B then spends £100 in shop.

Shop then deposits £100 with bank.

Bank can then lend £1000 to D.

Repeat.

Hrm, sounds screwed up, could never work

[padders]

Hrm, sounds screwed up, could never work

It works perfectly well while everyone trusts it works.

If everyone was forced to do economics at school, our economy would likely work somewhat differently. There is nothing bad about how the money supply works, but it does depend on expectations, and those expectations are really only managed by 99% of the population having complete ignorance in how it works.

[BuyingBear]

It works perfectly well while everyone trusts it works.

My example seems widly exponential. No wonder it's called an 'hallucination'.

We exchange cool stuff for bits of paper on trust.

Edited October 5, 2005 by BuyingBear

[Smell the Fear]

I've often wondered how this works? Surely it's just a matter of supply and demand. For every borrower there must be a saver. If the interest rate falls I might consider moving my savings somewhere else. This will create a distortion.

I believe that we are currently seeing a situation where the free market forces are working despite what the MPC tries to do.

We are hearing that lenders are not passing on the full 0.25% cut that we had in Aug. At the same time HSBC have just told me that they've raised the IR on my online saver account to 4.75%. Actually I'm gonna dump the lot into a Cahoot account that I've just opened which offers 5.25%.

LIBOR for 3 months is 4.59% (set this morning). This is the wholesale rate that banks lend to each other. Now if there is indded a (relatively) unlimited supply of money at 4.59% available to the banks, then why the hell will Cahoot offer me 5.25%. Yes, there has to be some fat in there to account for default risk (Cahoot and hence Abbey going bust), but I'm sure this is already taken into account and Abbey could borrow very close to (if not at) 4.59%.

ISA's offer 5% best case (Halifax).

Try to get a secured loan and the best you will find is about 6%. As shown, I can get 5.25%. Most mortgages seem to revert to a variable rate of between 5.5% and 6.5% once discounts/fixes expire.

Are we therefore seeing that the real rate at which we are lending/borrowing is a mid market of around 5.5%.

Banks typically overlend, so they need to fund their shortfall by borrowing overnight from the BoE. As such the rate at which the BoE lends them money (which it creates by making a keystroke on a computer) determines the rate at which they can lend to the next customer who wants a loan.

The reason why they pay you more for your ISA is that they correctly assume that you are happy to leave the money there for quite a long time. This allows them to create loans with little fear that you will pop in and withdraw all your savings.

As has been mentioned already, they lend out 91.5% of the cash you deposit. This then gets deposited by the borrower or by the person he pays it to, and the banks can create another loan on the back of it. By this method, an original deposit creates 11.5 as much money in the economy (this is the money multiplier effect). As such only a small amount of our money supply is unemcumbered with debt. The vast majority only exists because the banks lent it to someone.

Effectively we are all using the same money simultaneously. If we all try to get our hands on the cash at once, the bank collapses. A basic con trick, which as someone else pointed out above, only exists because 99% (at least) of people are unaware of its existence.

[Dicky]

You're all wrong, Merv and chums gather around a Weegee board once a month and asked the question, do we raise rate, leave them flat or drop them.

Might explain the 1.1 Trillion in debt now, why or why don't they just get a working Weegee board.

[theChuz]

You're all wrong, Merv and chums gather around a Weegee board once a month and asked the question, do we raise rate, leave them flat or drop them.

Might explain the 1.1 Trillion in debt now, why or why don't they just get a working Weegee board.

Ouija board.

Im not one to correct spelling usually but its a cool word, plus i cant let you get things from the darkside wrong

[Smell the Fear]

You're all wrong, Merv and chums gather around a Weegee board once a month and asked the question, do we raise rate, leave them flat or drop them.

Might explain the 1.1 Trillion in debt now, why or why don't they just get a working Weegee board.

Well that's conclusive evidence that ouija boards are extremely evil.

Can someone do a clever photoshop on that?

[theChuz]

Would make a good newspaper cartoon i snippet i reakon.

(now that its been suggested it probably will be) im sure journos actually soure stuff from internet forums)

[loophole]

Hi I'm one of those people who have been following the site for ages but never bothered to register.

A colleague told me about the site and I have never looked back, I can't believe how many people fool themselves into believing that everything will be alright. I'm a young FTB on a decent wage but have no intentions of buying yet

Anyway I read an article on how banks make money from nothing and couldn't believe that it was possible, but it is, this is how they do it:

http://www.prosperityuk.com/articles_and_r...cles/howbcm.php

[jpidding]

Hi I'm one of those people who have been following the site for ages but never bothered to register.

A colleague told me about the site and I have never looked back, I can't believe how many people fool themselves into believing that everything will be alright. I'm a young FTB on a decent wage but have no intentions of buying yet

Anyway I read an article on how banks make money from nothing and couldn't believe that it was possible, but it is, this is how they do it:

http://www.prosperityuk.com/articles_and_r...cles/howbcm.php

Thanks for the link.

OK, so the banks do in effect create money by repeatedly loaning the deposites, which then get redeposited and reloaned.

But my original point stands....for every one they loan to they have a depositer. A bank with deposites and assets of £100,000 cannot make a loan of £1,000,000 as was suggested by earlier posters.

Thus we have a free market with depositers and borrowers. If someone receives money for goods/services (from someone who has borrowed that money from the bank) and they decide not to put it back in the bank, but put in into gold, foreign currency or Anglo Bubblies then a shortage is created and the next person cannot borrow. Thus interest rates must rise to re-attract the depositers. This is why it is important for the govt to keep the currency strong for it to be attractive to outside investers.

Speaking to a friend who works in the City he said that the BOE does not really set rates. According to supply and demand banks lend money to each other at or close to (depending on credit rating) LIBOR. For those who dont know this stands for London Inter Bank Offered Rate. If all the banks started lending more money there would be a shortage and LIBOR would rise. When the MPC meet they are actually looking at LIBOR and making their decision based on that.

This is why the city is always knows what the MPC decision will be.

Here are the graphs:

LIBOR....

BEO Base rate....

Notice any correlation?

So dont blame the MPC when rates dont go the way you want them to....blame the free market!

James.

Edit.

Note that BOE base rate lags LIBOR as the MPC are looking at recent historical data to set rates for the next month.

Edited October 6, 2005 by jpidding

[OnlyMe]

James,

Interesting piece about LIBOR and BOE rates.

There is a spanner to put into the works, the last rate cut was pre-empted by the lenders by a few weeks, it did not look like a response of LIBOR to anything specific it looked for all the world like jumping the gun on a KNOWN BOE rate change.

If the banks know in advance of key changes then the BOE rate is not following or being dragged by the LIBOR rate as such - it is merely responding in anticipation of what is known or most likely to happen.

Edited and graph added. (Line points to the last LIBOR step change - notice in the past these were more in lock-step with timing of BOE announcements.

Very, very odd.

Edited October 6, 2005 by OnlyMe

[jpidding]

James,

Interesting piece about LIBOR and BOE rates.

There is a spanner to put into the works, the last rate cut was pre-empted by the lenders by a few weeks, it did not look like a response of LIBOR to anything specific it looked for all the world like jumping the gun on a KNOWN BOE rate change.

If the banks know in advance of key changes then the BOE rate is not following or being dragged by the LIBOR rate as such - it is merely responding in anticipation of what is known or most likely to happen.

Edited and graph added. (Line points to the last LIBOR step change - notice in the past these were more in lock-step with timing of BOE announcements.

Very, very odd.

It's the old chicken and egg theory at work. Often shares drop on the anticipation of bad news. When the news is announced the shares can rise if the news was not as bad as expected. Undoubtedly the MPC decision greatly swings sentiment and you're right, the expectation of a 0.25% drop was widely felt in Aug prior to the decision.

At the end of the day if all the banks start lending money to retail customers and they run short, then the BOE has to lend them the money overnight. If the BOE starts running dry then they have to issue more government debt (bonds) onto the foreign markets to raise more money. This selling off of Sterling tends to weaken the currency, which it turn pushes up import costs and hence inflation.

Interesting stuff.

James.

[Mushroom]

Here's a suggestion for the MPC and therefore G Brown.

Remove sentiment from rate setting.

Just like automated trading, use a programme.

Would that be possible?

Anyone know if the Treasury Model would do it?

[Mr_Sminty]

Read in Finance this week that the BoE does not really have any control over interest rates realistically and cannot move them materially. This surprised me and they are more like the MET in predicting the weather, whereby they are in reality second guessing the market themselves and they cannot buck the market

For instance they could not raise rates by 2% or drop them by 10%. In fact its not the Banks aim to set interest rates(in this context actually controlling the rate and supply of money from a market intervention point of view) and just to control inflation within the governments target level, and raising and lowering interest rates is the way of doing this by sending signals to the economy

Its argued that the BoE role in the economy is really psychological, whereby raising or lowering interest rates tells people and companies to spend or tighten their belts, and they actually respond accordinly. If this sounds a bit odd heres another example of if the BoE could control interest rates then they would set rates for different borrowers, for example the BoE would like to set the rates for home loans to curb HPI, but encourage savers to put money away for their pensions, but again it is the market that sets these rates in reality.

Something to maybe think about, cannot say I am an expert but sounds reasonable when one thinks about how mortgage rates rise and fall with BoE decisions in actuality, with cuts not being passed on etc. If this is the case it will take a downturn in the fundamentals of the economy and rise in bad debts etc. till a restriction in the money/credit supply will come into effect due to lenders restricting liabilities etc. and the real cost (interest) rate will increase.

Wouldnt mind any comments on the above or differing views if anyone has some

POsted the above back in AUgust, couldnt really get my head around but it sounded about right but glad you have someone in the City who backs up the notion that the market sets rates.

[Harry Sacks]

At the end of the day if all the banks start lending money to retail customers and they run short, then the BOE has to lend them the money overnight. If the BOE starts running dry then they have to issue more government debt (bonds) onto the foreign markets to raise more money. This selling off of Sterling tends to weaken the currency, which it turn pushes up import costs and hence inflation.

James.

We do this alot, right? This is why our IR tend to be higher?

[jpidding]

We do this alot, right? This is why our IR tend to be higher?

Our government is borrowing a lot to fund public spending. Not only is consumer spending drying up, but the government will not be able to keep borrowing to prop up the economy. We are already in breech of European rules on borrowing as a percentage of GDP.

Our friend Gordon will look for new ways to keep the runaway train rolling....stealth taxes, manipulation of unemployment/inflation figures, moving the goalposts on borrowing metrics etc. Dont forget he and Tony made a pact. I think he has to keep things running for another year or so then he'll get the keys to next door.

He then won't care about the ecomony so much. I'm pretty sure that Labour will lose the next election. By then he will have made his mark in the history books (everyone remembers the PM, but not the chancelor).

The pyramid selling game can only go on so long

I just hope that my savings aren't eroded by negative real interest rates.

James.

[infected]

The MPC decides the short term interest rate.

The BoE deliberately keeps banks short of cash so that they have to borrow money at the end of each working day. Initially the banks have to deal with each other before they approach the BoE for the remainder - this will be lent to them at at the rate decided by the MPC.

Naturally the market rate will deviate from the official rate but the threat of arbitrage means this is never significant.

When the rate moves ahead of an MPC meetings, this will be due to rational expectations anticipating their decision.

Recently banks have been offering customers attractive rates on deposits (e.g. 5.5%). This is because to continue lending into a credit expansion, regulations determine that they need more deposits.

[E Powell]

A certain group of individual receive payment from an organisation to keep

prices low.

Bung or backhander - call it want you want.