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Something new about the economy is the last ten years is the higher proportion of fixed rate loans. I think this must change the dynamics of the market quite a bit. Here's my theory:

  • With a rate increase, those thinking about buying of moving would be immediately discourage so this feeds through to the market very quickly
  • Inflationary spending on the other hand is not turned off immediately by the rate rise if most of the economy is on fixed rate terms. This is different to the 80's and to some extent 90's when inflation would be stopped more quickly by a rate rise.

Is the net effect of this that now stopping inflation is much more tricky because inflation now needs to be antipated rather than be a reality? It's much more difficult to convince people that a rate is needed now to stem off inflation in a years time. The net result is waiting for the CPI to hit the upper limit of 3% and then trying very hard to put the lid back on.

I see the fixed rate economy as far more difficult to control with little adjustments here and there. I therefore think that it's likely that we could see an IR/Inflation oscillation occur - a bit like a metaphorical fishtail skid where the car goes one way, the driver turns but overcompensates, repating this several times before hitting a tree. Only this time, there are no airbags.

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I can see the logic of your theory, certainly.

Perhaps it means that those borrowing now must bear all the burden rather than spreading it across everyone? By which I mean that rates need to jacked severely to kill the market for mortgages and MEW stone dead to make up for those who are insulated by fixed rates.

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As I argued on the 'Will a fall actually help people?' thread:

you're buying a property from scratch, you'll make an offer based on what monthly mortgage payments you can afford, given interest rates at the time. Let's say the HPC happens against a backdrop of rising interest rates, and in three years time rates are at 10%. Before deciding whether or not to make an offer on a 'crashed' property, I'll think about what monthly repayments I can afford, based on IRs now and where they're likely to go in the immediate future. If IRs change after you've bought, you're stuck with the size of the mortgage you've got, and therefore have to plan your finances in order to service it in response to IRs, fixes on offer, etc. But if you're deciding whether or not to take the mortgage out in the first place, you have a lot more flexibility. You can simply make a lower offer in order to take IRs into account, and if lower offers are the only offers on offer, so to speak, there's not much that sellers can do about it.

In this context, for IRs, read 'fixes currently being offered by lenders'. So those borrowing now won't bear all the burden, because they'll simply refuse to pay capital sums for properties which don't take into account mortgage rates on offer relative to their incomes. If anything, current owners will be hoisted by their own petards, because their desire for fixes will drive mortgage rates up for FTBs, and consequently drive down the capital sums they're willing to pay for their homes.

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I can see the logic of your theory, certainly.

Perhaps it means that those borrowing now must bear all the burden rather than spreading it across everyone? By which I mean that rates need to jacked severely to kill the market for mortgages and MEW stone dead to make up for those who are insulated by fixed rates.

Dont take too much notice of me having had a couple of beers but; it has occured to me that credit controls could have a part to play. Its been done before, but done and left alone. Maybe credit control levels have to be moved up and down on a monthly basis like interest rates, depending on conditions.

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Dont take too much notice of me having had a couple of beers but; it has occured to me that credit controls could have a part to play. Its been done before, but done and left alone. Maybe credit control levels have to be moved up and down on a monthly basis like interest rates, depending on conditions.

I dont think credit controls can be introduced, we live in a global marketplace millions of banks and organisations are willing to lend you money in a multitude of currencies. IMHO internet and freedom of financial information, means the cat is out of the bag. As for IRs, its going to be a struggle to keep inflation down, when inflation gets out of control and interest rates are raised people around the world look to the currency as a place for there savings....

Edited by moosetea

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I dont think credit controls can be introduced, we live in a global marketplace millions of banks and organisations are willing to lend you money in a multitude of currencies. IMHO internet and freedom of financial information, means the cat is out of the bag. As for IRs, its going to be a struggle to keep inflation down, just look at NZ....

Doesn't the Bank of England still use the reserve requirement as an instrument of monetary policy?

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Doesn't the Bank of England still use the reserve requirement as an instrument of monetary policy?

Special deposits and the 'corset' were effectively abolished in 1980...

'Evaluation of individual housing policies and technical report' [June 2005] [PDF]:

http://www.communities.gov.uk/embedded_object.asp?id=1150855

'Corset': Formally the 'supplementary special deposits scheme'. Reintroduced in 1973, and activated for almost two years in 1975-76 and for 11 months in 1977-78, this had the effect of limiting banks' ability to lend by limiting the growth of interest-bearing liabilities on their balance sheets. If Bank of England limits were breached, the bank was required to lodge deposits with the Bank for which they received no interest (ibid.). The Corset did not apply to Building Societies, so greatly advantaged them. The Corset's effectiveness was undermined by the abolition of exchange controls in 1979 and was abolished in 1980, following Green Paper (Cmnd. 7858 March 1980).

Here's a little history of special deposits and supplementary special deposits (the 'corset')...

'The UK economy -- the past forty years':

http://www.bized.ac.uk/dataserv/chron/kf5579.htm

1958 3 Jul Ceiling on total bank advances to be abolished. Proposals for special deposits announced.

[...snip...]

1960 28 Apr Credit squeeze: hire purchase restrictions reimposed; first call for special deposits.

[...snip...]

1961 25 Jul Mini-Budget: Pay Pause measures announced -- brake on wages in the public sector (government hopes that private sector will follow suit); bank rate raised to 7% from 5% and further call for special deposits; 10% surcharge on Customs and Excise duties.

[...snip...]

1965 29 Apr Bank of England calls for special deposits.

[...snip...]

1970 29 Oct Special deposits (which are used to vary clearing banks' reserves and hence liquidity ratio to influence the money supply) with the Bank of England raised from 2.5% to 3.5%.

[...snip..]

1972 9 Nov Bank of England calls for special deposits, removing about £220 million from the banking system during the following five weeks.

[...snip...]

1972 21 Dec Bank of England calls for special deposits to take almost a further £450 million out of the banking system.

[...snip...]

1973 13 Nov Government announces record monthly visible trade deficit of £298 million for October. The Bank of England calls for further special deposits and raises the minimum lending rate to 13% from 11.25%.

[...snip...]

1973 17 Dec Mini-Budget: Hire purchase controls reintroduced. Supplementary Special Deposits Scheme -- the corset -- introduced, by which banks and finance houses required to place special deposits with Bank of England if their growth in interest bearing liabilities exceeds specified limits.

[...snip...]

1974 31 Jan Bank of England announces the release of 0.5% of bank and finance house special deposits to ease the liquidity position of the banking system in order to avoid a sharp rise in overdraft rates.

[...snip...]

1974 4 Apr Bank of England announces 1% release of special deposits to the banking system to ease pressure on UK interest rates.

[...snip...]

1977 11 Aug Bank of England suspends Supplementary Special Deposits Scheme (corset) controls on growth of banking system's resources.

However, in recent years some commentators have advocated the reintroduction of the corset...

'Watch Brown's corset come out of the closet for a nation on the never-never' [November 2002]:

http://scotlandonsunday.scotsman.com/busin...m?id=1277042002

Gordon Brown needs a corset, and if he looks in the Downing Street wardrobe, he should find one. It was hung there by Sir Geoffrey Howe, who mistakenly thought he had no need for it, but it was worn with great effect by his predecessors as chancellor, Denis Healey and Tony Barber.

The corset was the strangely-termed mechanism for controlling credit: when things were getting out of control, the Treasury pulled the strings and the corset tightened, causing banks to reverse their advances.

Brown needs to tighten credit now, but he finds that the traditional kit for doing so is out of fashion. When past governments wanted to stop us spending tomorrow's money on today's luxuries, they could force finance companies to make us pay up to 40% of the price in cash and repay the rest over no more than two years. That stopped people buying cars.

They told credit card companies to increase our minimum monthly payments. They instructed hire-purchase companies to make the never-never more finite. Chancellors could order the clearing banks to make special deposits at the Bank of England, thus giving them less to lend to the public.

Howe scrapped all that, leaving interest rates as the only control on credit. As credit-card rates show, that is not always an effective tool -- but Brown has handed even that sanction to the bank, and while the independent bank is also worried about our borrowing, it can't afford to damage the rest of the economy by raising rates.

Whether we call it a corset, a girdle or stays, Brown needs something to restrain Britain's bulging boom in credit. Equity-withdrawal on mortgages is running at £40bn a year, financing 6% of all consumer spending; the average person has £1,400 of credit card debt.

Britain's consumer-led boom has been financed from tomorrow's earnings and, as Mr Prudence knows, that cannot go on for ever. But if consumers even stop increasing their debt, it will depress growth; if they start repaying it we could head for recession; and if they don't repay, the banks are in trouble.

He has already left it too late to act, but compared with his current straitjacket, a corset seems preferable. Brown needs us to stop borrowing so that he can start borrowing. The time for him to show us this garment will be the pre-budget report expected this month. He can have it remodelled to suit today's fashion, but Brown has to make us tighten our belts.

'The Parlous Condition of Britain's Economy!' [June 2004]:

http://www.axisoflogic.com/artman/publish/article_9508.shtml

Previously, Government worked, in tandem with the Bank of England (B o E), Britain's Central Bank, to modify the economic effects of excessive lending by banks, by invoking "The Corset". The Corset meant that banks and lending institutions, had to increase their effective liquidity ratios, by depositing what are called "Special Deposits", with the B o E, at lower than market rates, thereby increasing the cost of lending, reducing "Hot" flushes of money in the financial system and penalising over-exuberant lenders.

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<snip>

Here's a little history of special deposits and supplementary special deposits (the 'corset')...

<super snip>

Superb post. Thankyou.

So has Gordon shown no interest in this?

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