What If Interest Rates Are Never Raised?

[BillyShears]

Let's say that in the UK the government has thoroughly painted itself into a corner and does not dare to raise interest rates. Let's say that even if the government changes, any new government would also be too scared to raise interest rates. So rates stay on hold for years. What happens then?

Billy Shears

[y0ssarian]

capitalist Governments dont set interest rates, the market does

[New Darker Law]

As unlikely as that event seems (IMO) it will lead to a exodus of our nations talented youth.

What would be keeping them hear? No affordable housing. Huge student debts stifling their ability to get on with their lives. Economics of having children just not adding up.

In the short term the country would be screwed. In the long term.....it doesn't bear thinking about.

NDL

[frugalista]

Let's say that in the UK the government has thoroughly painted itself into a corner and does not dare to raise interest rates. Let's say that even if the government changes, any new government would also be too scared to raise interest rates. So rates stay on hold for years. What happens then?

Billy Shears

I am guessing:

2006 -- BOE 4.5%, FED 4.75%, ECB 2.75%

-- pound begins to slide in value a bit.

-- petrol and other goods creep up in price.

-- house prices hold up just about in nominal terms.

-- a few foreign investors pull out of the UK.

-- government borrowing looking a bit high

2007 -- BOE 4.5%, FED 5.25%, ECB 3.75%

-- people start cutting back spending to bare essentials in order to cover rising bills.

-- jobs in luxuries are lost -- unemployment rising.

-- pound is now in serious decline.

-- house prices slipping a bit. A large number of properties for sale.

-- many foreign investors pulling out.

-- government going badly into the red.

-- public sector spending cutbacks.

2008 -- BOE 4.5%, FED 6%, ECB 4.5%

-- pound has now crashed.

-- personal insolvency and reposession reaching scary levels.

-- jobs dependent on non-essential service industries lost.

-- jobs dependent on inward investment are lost.

-- house prices crashing.

-- jobs dependent on housing market are lost.

-- public sector jobs go.

2009 -- Tories elected.

2010-2025 -- A repeat of 1995 - 2010.

frugalista

[padders]

I am guessing:

2006 -- BOE 4.5%, FED 4.75%, ECB 2.75%

-- pound begins to slide in value a bit.

-- petrol and other goods creep up in price.

-- house prices hold up just about in nominal terms.

-- a few foreign investors pull out of the UK.

-- government borrowing looking a bit high

2007 -- BOE 4.5%, FED 5.25%, ECB 3.75%

-- people start cutting back spending to bare essentials in order to cover rising bills.

-- jobs in luxuries are lost -- unemployment rising.

-- pound is now in serious decline.

-- house prices slipping a bit. A large number of properties for sale.

-- many foreign investors pulling out.

-- government going badly into the red.

-- public sector spending cutbacks.

2008 -- BOE 4.5%, FED 6%, ECB 4.5%

-- pound has now crashed.

-- personal insolvency and reposession reaching scary levels.

-- jobs dependent on non-essential service industries lost.

-- jobs dependent on inward investment are lost.

-- house prices crashing.

-- jobs dependent on housing market are lost.

-- public sector jobs go.

2009 -- Tories elected.

2010-2025 -- A repeat of 1995 - 2010.

frugalista

They will have to be more careful about letting the pound crash now that we are an oil importer, however without oil it would probably have already crashed.

[Without_a_Paddle]

As unlikely as that event seems (IMO) it will lead to a exodus of our nations talented youth.

What would be keeping them hear? No affordable housing. Huge student debts stifling their ability to get on with their lives. Economics of having children just not adding up.

In the short term the country would be screwed. In the long term.....it doesn't bear thinking about.

NDL

Long term low interest rates encourage investment and economic growth.

The monetary policy of this govt and many others has changed to an inflation targetting policy. Take a look at interest rates over the last few decades. Note the change since the early 1990s when this policy was set in place by the Tories. See how much more stable rates have become since then.

Lowish IRs are here for a while. Like I said, long term low interest rates encourage investment and economic growth.

Sure, it can't last forever, but I don't see it changing much this side of the next election.

The next few years will see lowish rates, more public borrowing and spending. All geared towards propping up the economy prior to the next election. A HPC is not a votewinner.

[Elizabeth]

Let's say that in the UK the government has thoroughly painted itself into a corner and does not dare to raise interest rates. Let's say that even if the government changes, any new government would also be too scared to raise interest rates. So rates stay on hold for years. What happens then?

Billy Shears

Isn't that the bit where pulling against the tide of the world economy causes the currency to rapidly devalue and the government responds by fixing a relative value against other currencies? Before you know it your furtively exchanging your British pounds for an Australian dollar each behind the back of the Odeon cinema in Camden.

[BillyShears]

Apart from frugalista, most people seem to have been quite reserved with their predictions. Personally I would have thought that serious economic meltdown would be a consequence of failing to raise interest rates if the economic conditions made it necessary. I note padder's comment on the price of imported oil. That could be a vicious circle as a devaluing pound makes energy more expensive which adversely affects the economy and so on.

Billy Shears

[frugalista]

Apart from frugalista, most people seem to have been quite reserved with their predictions. Personally I would have thought that serious economic meltdown would be a consequence of failing to raise interest rates if the economic conditions made it necessary. I note padder's comment on the price of imported oil. That could be a vicious circle as a devaluing pound makes energy more expensive which adversely affects the economy and so on.

Billy Shears

Agree. Failing to raise IRs merely delays the inevitable and makes it worse when it comes. It is like taking half a course of antibiotics, then stopping when the symptoms go away.

So, raise them now and get the pain out of the way, or delay and it will be much worse.

Lawson cut rates from 85 to 88 and paid the price.

The trouble is, if you believe your own hype ("no more boom and bust", "iron chancellor" etc.) then you think you have some other option, or that the old rules do not apply to you.

frugalista

[Elizabeth]

Apart from frugalista, most people seem to have been quite reserved with their predictions. Personally I would have thought that serious economic meltdown would be a consequence of failing to raise interest rates if the economic conditions made it necessary. I note padder's comment on the price of imported oil. That could be a vicious circle as a devaluing pound makes energy more expensive which adversely affects the economy and so on.

Billy Shears

Whadaya mean "Apart from Frugalista"? I'm offended. Billy READ MY POST

[padders]

Apart from frugalista, most people seem to have been quite reserved with their predictions. Personally I would have thought that serious economic meltdown would be a consequence of failing to raise interest rates if the economic conditions made it necessary. I note padder's comment on the price of imported oil. That could be a vicious circle as a devaluing pound makes energy more expensive which adversely affects the economy and so on.

Billy Shears

The problem is even bigger than just oil as well, the reason we have had low inflation (even though it's higher than reported) is because the cost of imported goods has gone down year on year. If our currency devalues then this will change and we will import inflation.

In a normal situation, devaluing your currency is a good thing because it makes your imports more expensive and exports cheaper so basically kick starts your economy. The problem is when an economy dosen't really make anything anymore, imports are pretty price inelastic. People will still to want ipods, cars, computers etc they will just have to pay more for them, ie inflation.

So we are sort of stuck. If the government let's the currency fall we will suffer inflation pretty rapidly. If however they raise interest rates to keep the currency high then we will get a major recession because of people's over exposure to variable rate mortgages.

I wouldn't want to be the next chancellor.

Agree. Failing to raise IRs merely delays the inevitable and makes it worse when it comes. It is like taking half a course of antibiotics, then stopping when the symptoms go away.

So, raise them now and get the pain out of the way, or delay and it will be much worse.

Lawson cut rates from 85 to 88 and paid the price.

The trouble is, if you believe your own hype ("no more boom and bust", "iron chancellor" etc.) then you think you have some other option, or that the old rules do not apply to you.

frugalista

It amazes me how people forget this, I learnt this when I was 15 for GCSE economics, the low IRs and also the changing tax structure that encouraged everyone to quickly go out and buy property.

[Without_a_Paddle]

Agree. Failing to raise IRs merely delays the inevitable and makes it worse when it comes. It is like taking half a course of antibiotics, then stopping when the symptoms go away.

So, raise them now and get the pain out of the way, or delay and it will be much worse.

Lawson cut rates from 85 to 88 and paid the price.

The trouble is, if you believe your own hype ("no more boom and bust", "iron chancellor" etc.) then you think you have some other option, or that the old rules do not apply to you.

frugalista

But Lawson had a totally different monetary policy back then in the mid 1980s. He targetted the £ (shadowed the £ against the German DMark) and this created the boom in the economy. A couple of tax busting budgets just fanned the flames of consumer spending. Investments poured into the UK and the economy overheated (not just the housing market) and inflation was in double digits. He put up IRs to 15% to stem the inflation. The housing market nosedived because rates doubled in a very short time.

Our monetary policy today targets inflation. So unless the govt changes monetary policy (or the Treasury gives the BOE a different inflation target) I don't see IRs rising much in the next few years.

Unlike the mid 1980s our economy is not overheating at the minute so I don't see a huge hike in rates on the cards.

Edit:

Also, although I didn't listen to all of the budget speech by GB I did hear a bit of Cameron's reply to it.

All I heard were a few meaningless sound bites which were thinly veiled pointers to the fact that Cameron was younger and fresher than Brown.

I didn't hear him lay into GB asking for IR rises because the economy was going down the pan. (maybe I missed that bit)

Also I caught a glimpse of the shadow chancellors reply to the budget. He didn't seem that critical of the govts/BOE IR setting policy either.

Edited March 24, 2006 by Without_a_Paddle

[BillyShears]

Whadaya mean "Apart from Frugalista"? I'm offended. Billy READ MY POST

I must have been writing my post when you posted yours, and hence hadn't read it, even though my post appeared later than yours.

Billy Shears

[frugalista]

But Lawson had a totally different monetary policy back then in the mid 1980s. He targetted the £ (shadowed the £ against the German DMark) and this created the boom in the economy. A couple of tax busting budgets just fanned the flames of consumer spending. Investments poured into the UK and the economy overheated (not just the housing market) and inflation was in double digits. He put up IRs to 15% to stem the inflation. The housing market nosedived because rates doubled in a very short time.

Our monetary policy today targets inflation. So unless the govt changes monetary policy (or the Treasury gives the BOE a different inflation target) I don't see IRs rising much in the next few years.

Unlike the mid 1980s our economy is not overheating at the minute so I don't see a huge hike in rates on the cards.

I agree some things are very different, but the important elements are the same.

In particular, I think the economy *has* overheated. Not in the inflation sense, but in the debt sense. Consumer and housing debt is very high. Many people who might otherwise be unemployed have got jobs on the basis of that debt rising over the last few years. A lot of recent growth has been ephemeral. It is based on debt, not productivity improvements. The debt must be repaid, and some of the growth must as a consequence be reversed. Monetary policy can only really affect the timing of this process, not the eventual outcome.

frugalista

[Sarah Beeny!]

I'm nowhere near as clever as most here on economics (but learning), however I get the feeling that we HAVE to be above US rates for obvious reasons.

Interestingly there was a very good article in The Telegraph (Business, yesterday I think) from the new Fed chief. The near full page article had many quotes that he may have got from this site!!!! It was uncanny, the best part was on interest rates (paraphrasing), 'The housing market can go to hell, don't expect a bail-out'. It was great stuff, inverted yeild curve, Japanese banks, T-Bills, MEW etc...

[BillyShears]

I agree some things are very different, but the important elements are the same.

In particular, I think the economy *has* overheated. Not in the inflation sense, but in the debt sense. Consumer and housing debt is very high. Many people who might otherwise be unemployed have got jobs on the basis of that debt rising over the last few years. A lot of recent growth has been ephemeral. It is based on debt, not productivity improvements. The debt must be repaid, and some of the growth must as a consequence be reversed. Monetary policy can only really affect the timing of this process, not the eventual outcome.

frugalista

I'm not able to analyse or really understand the factors that influence what optimum interest rates should be. But in terms of personal debt, it seems much simpler. If somebody spends more money than they have at the moment by going into debt, then at some point in the future, they must be spending less than they could because they are paying off the debt! And because of interest payments, they must overall buy less "stuff" than they would have if they had never gone into debt. I saw a television program on doorstep lenders. They gave the case of one woman who borrowed the money to go on holiday. They calculated that she would end up paying back three times the cost of the holiday. Which meant that if she economised one year and didn't borrow the money for the holiday, that she should have had three equivalent holidays the next year and every year after that!

Billy Shears

[New Darker Law]

Long term low interest rates encourage investment and economic growth.

The monetary policy of this govt and many others has changed to an inflation targetting policy. Take a look at interest rates over the last few decades. Note the change since the early 1990s when this policy was set in place by the Tories. See how much more stable rates have become since then.

Lowish IRs are here for a while. Like I said, long term low interest rates encourage investment and economic growth.

Sure, it can't last forever, but I don't see it changing much this side of the next election.

The next few years will see lowish rates, more public borrowing and spending. All geared towards propping up the economy prior to the next election. A HPC is not a votewinner.

Whilst I don't completely disagree, I can't fully agree either.

Lower interest rates should lead to investment and economic growth. In a entrepreneurial and hard-working society that is the case. I'm afraid the UK isn't like that any more. Low interest rates have encouraged one of the largest consumer borrowing splurges in history. Low interest rates are wasted on this country.

If they remain low, the pain will only get worse. Better to start raising now and kill off the "dead wood" before the whole tree is terminal.

If by "lowish IRs" you mean sub 8% long term average (that is right isn't it?), I'd agree. However, I still think we'll see at least one quarter point raise by the end of this year.

NDL

[Once in a lifetime]

I can’t remember where I read it, (probably here)

"even when Governments carve their policies into stone- they quickly abandon them, when it suits."

[Marina]

Long term low interest rates encourage investment and economic growth.

That's the theory. The reality is that, for many businesses, the ever increasing competitiveness of the environment they exist in, means investment is not on. Running to stand still is the norm for many businesses.

This globalization thing is going to screw us completely.

Long term low interest rates encourage debt.

[jonpo]

If rates stay low forever.......

the people who bought gold were right.

[bazzzzzzz]

I am guessing:

2006 -- BOE 4.5%, FED 4.75%, ECB 2.75%

-- pound begins to slide in value a bit.

-- petrol and other goods creep up in price.

-- house prices hold up just about in nominal terms.

-- a few foreign investors pull out of the UK.

-- government borrowing looking a bit high

2007 -- BOE 4.5%, FED 5.25%, ECB 3.75%

-- people start cutting back spending to bare essentials in order to cover rising bills.

-- jobs in luxuries are lost -- unemployment rising.

-- pound is now in serious decline.

-- house prices slipping a bit. A large number of properties for sale.

-- many foreign investors pulling out.

-- government going badly into the red.

-- public sector spending cutbacks.

2008 -- BOE 4.5%, FED 6%, ECB 4.5%

-- pound has now crashed.

-- personal insolvency and reposession reaching scary levels.

-- jobs dependent on non-essential service industries lost.

-- jobs dependent on inward investment are lost.

-- house prices crashing.

-- jobs dependent on housing market are lost.

-- public sector jobs go.

2009 -- Tories elected.

2010-2025 -- A repeat of 1995 - 2010.

frugalista

IMO, for what it's worth, this is a realistic scenario.

Truth is, Brown will postpone the inevitable for as long as he can. He knows how indebted the nation is and I believe he is willing to sacrifice the pound until he becomes prime minister. (Assuming he does) He can't have the property market crashing, or appearing to crash in the face of increased interest rates before he becomes leader. I have no doubt he will let Sterling take a pounding in the short term to protect his position.The electorate will not tolerate falling house prices and other pain that will inevitably follow increased interest rates. And neither will labour MPs who will inevitably be facing a weakened power base in teh face of increased interest rates. 'Just one more election', they cry, 'at any cost' (to the nation).

He will let sterling take a bloody beating before he concedes.

Why not?

If he becomes primeminister his earning power will increase one hundred fold on leaving office no matter what happens. That is his primary objective as it is Blair's.

They will be guaranteed multi millionaires in an instant . But you have to become prime minister before that sort of earning power is guaranteed.

Edited March 25, 2006 by Baz63

[Warwickshire Lad]

Give people low interest rates at any time, and all they ever do is go on a property grab. It's burnt into the national psyche, helped by Thatcher.

[CrashIsUnderWay]

ultimately Billy, People stop saving. And that means higher rates to encourage them back, so IR MUST rise at some point (here we go here we go here we go...)