Are low interest rates the answer – or the problem?

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There is a near universal belief among economists, politicians and the public at large that low interest rates encourage economic growth. In the UK, we have had 0.5% bank rate since March 2009 and City economists keep putting back their estimates of when it might rise. The current consensus is that it will not happen until November 2015!

Having painted itself into a corner with interest rates, the Bank of England conjured up Quantitative Easing to further stimulate the economy. QE has not been without its detractors, both for its inflationary impact and because some think it benefits the banks rather than the real economy. The Bank of England admitted that the first bout of QE increased CPI inflation by 0.75% to 1.5%, but claimed that it boosted the economy by between 1.5% and 2%, reducing yields on medium-dated gilts by 1%.

The Bank of England gets its sums wrong

But was the Bank of England right? The Bank of International Settlements – the central bankers’ bank – thinks not. Instead of 5-25 year gilt yields falling by 100 basis points (1%), the BIS believes QE pushed them down by just 27 basis points (0.27%). And while the Bank reckons that the second bout of QE will be as effective as the first, the BIS disagrees: “It may be harder to achieve the same degree of effectiveness as with the initial programmes once the surprise or novelty element wanes”.

We have been arguing that the Bank is not only wrong about QE, but also about the effect of long-term negligible interest rates. On The World at One before Christmas, Bank of England Deputy Governor Charlie Bean was challenged on this. Less fluent than elsewhere, he stammered that, “Had we tried to rein inflation back sharply this year that would have led to too sharp a contraction in activity and what we would also find is inflation dipping well below the target next year.”

Despite saying, just over a year earlier, that savers should stop complaining and start spending to help the economy, Mr Bean now claims to “have every sympathy with savers. They weren’t the people who caused the financial crisis but they are carrying a considerable burden of the adjustment to it.”

Is it time to raise interest rates?

Given the state of the economy after almost three years of 0.5% base rate, it is remarkable how few people – other than us – have queried whether low interest rates are having the desired effect. Anthony Hilton, Financial Editor of the London Evening Standard, is almost alone in daring to challenge the consensus. Recently he wrote an editorial headlined: “Time to look at raising interest rates?”

“There is,” he wrote, “an argument that the policy of minimal interest rates is approaching its sell-by date. The problem is it perpetuates the sense of abnormality in the economy, and as such it could hinder rather than help the return to normality which everyone craves.” Low interest rates are not stimulating corporate investment, he points out, but serving to remind companies of the abnormality of the economic environment.

He acknowledges that rate rises might cause problems to over-extended borrowers but reckons that many problem loans have already been dealt with and that higher rates would inject some urgency into sorting out the rest. Some urgency is clearly needed, for the persistence of the low interest rate environment is not curbing the appetite or demand for debt. According to the Bank of England, there is “little sign that households in aggregate are making an active effort to pay down debt more quickly than in the past”, a survey by Shelter finds that almost a million people have taken out payday loans to help pay rent or their mortgage in the past year while offers of 0% interest on credit card debt have again become common.

Hilton believes there would be several benefits from raising interest rates. It would put money back in the pockets of those who have saved to supplement their pensions. As we have consistently argued, much of this extra income would be spent, boosting consumption.

Banks, building societies and insurance companies, struggling on minimal profit margins with rates near zero, would be healthier and thus more likely to lend.

Higher rates would also slash the deficits of pension funds and lift a major funding burden from companies.

People are emotional, not rational

Hilton concludes that, “We are running with an economic theory that assumes people are rational rather than emotional. Conventional economic wisdom says low interest rates deliver economic activity because they make it easier for entrepreneurs to turn a profit on an investment. But since Keynes in the Thirties we have also understood that low interest rates might not drive such behaviour when people are simply too depressed or too scared to think their projects will work. That is where we are now. When rock-bottom interest rates present a daily reminder that things are far from normal, it is surely possible they are adding to the uncertainty rather than bolstering our fragile confidence. Perhaps it is time to see them as part of the problem, rather than part of the solution.”

Even Mr. Bean acknowledges that low interest rates can cause problems. “If you have a very long period of low interest rates it leads to a build up of distortions, takes away the incentive for people to save and that’s something we want to encourage in the long run.”

If interest rates do not rise until late 2015, will there be anybody left willing to save? Will there be a new generation of savers or will young people, having seen how savers sacrificed to bail out the imprudent, consider it a foolhardy thing to do?

According to This Is Money on 29th December: “The Governor is under intense pressure from the likes of campaign group Save Our Savers who predict that Britons will lose £42billion over the next 12 months thanks to the toxic combination of low rates and high inflation eating away at the spending power of cash.”

We intend to keep that pressure up in 2012 and hope that more commentators will break with the consensus, follow Anthony Hilton’s lead and question the policy of long-term low interest rates. Otherwise, if those City analysts are right, we could be in for four more years of this lunacy.

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15 Comments

1. frances

   January 4, 2012 at 12:19 pm

   Its mind blowingly obvious to all of us who are totally dependant on savings income that low interest rates are doing no good whatsoever
   My income has dropped by over 1/3rd and my measly 1/2 state pension increase of CPI will not begin to cover increases in cost of food let alone any other basic cost of living .
   I have far far too many friends in the same boat and even David Camerons latest speech made no mention of Saver/Pensioner suffering .
   The biggest prioblem as i have said before is a huge proportion of savers are Pensioners who are not computer literate and cant even afford a computer so the ground swell of anger thats definitely out there has little outlet.
   MPs ignore letters
   Ministers take months to reply and even then its platitudes
   The Government and the MPC have got to stop pretending low interest rates are the solution…theres 7 savers to every one mortgage holder and all those savers cannot afford to spend
   The most basic maths shows why the economy cannot grow under those conditions ……..its utter madness and Mervyn King and MPC are crazy if they do not recognise this and stop the crocodile tears and ostrich policy

   Recommend (13)
2. John H

   January 4, 2012 at 2:38 pm

   The BoE’s low base-rate policy is pretty much discredited. The excuse used to be that this approach would help to stimulate investment by businesses, particularly amongst the SMEs seen as vital to the economy. Despite project Merlin or whatever other guff this has signally failed.

   My long-held view is that the Government’s unspoken policy is to protect inflated house prices at all costs and the BoE does as it’s told. The nearer we get to the NEXT election this will become all the more imperative.

   Unless pressed, Ministers will always tend to stress the “benefits” of low base-rates and some simply refer to “mortgage rates”. Otherwise they mouth platitudes towards savers (as noted by Frances) but offer nothing.

   It’s worrying that a medium-term inflation undershoot is being touted by the BoE – another excuse to keep base-rates low. Strange that they didn’t show the same concern about the opposite.

   In terms of the wider economy, as stated – not just low but “abnormal” base rates, are achieving nothing as responsible savers are cheated out of income and their capital destroyed.

   Recommend (15)
3. Will

   January 5, 2012 at 12:21 pm

   “My long-held view is that the Government’s unspoken policy is to protect inflated house prices at all costs and the BoE does as it’s told.”

   “It’s worrying that a medium-term inflation undershoot is being touted by the BoE – another excuse to keep base-rates low. Strange that they didn’t show the same concern about the opposite.”

   The first quote shows why they are not concerned about the opposite scenario mentioned in the second quote. The BOE are inflating the country’s debt problem away and doing all they can to appease markets and convince them this isn’t the case. The result will be disastrous in the long run. Homeowners will be able to claim that the number on the price tag of their house hasn’t dropped, but that number itself won’t be worth anything like what it used to be worth. The upshot is their houses will be worth less in real terms, but the government are hoping they’ll be too stupid to realise that. The corollary of this approach is that it’s not just those who overburdened themselves with debt to buy overpriced houses – inflating away a debt problem also inflates away savings. Which is why I’ve been steering clear of sterling.

   Recommend (9)
4. Alan

   January 29, 2012 at 9:08 am

   You know, it’s not just pensioners who are losing out. My wife and I and our friends, all in our early 30′s, cannot see any reason to invest in anything. As interest rates can only go up, so house prices can only come down. Is the stock market the place to put all our life savings? Under the mattress is probably safest… the same attitude that’s kept Japan in the doldrums for over a decade.
   How can people of my generation change this? Is there a polical party we can vote for that shares our frustrations?

   Recommend (7)
5. frances

   January 30, 2012 at 1:33 pm

   If 30 somethings have money to invest or save they are in a far far better situation than the majority of todays pensioners
   When we were in our 30s there was no hope of having savings you just made ends meet
   its only when children are off your hands that you can finally start to save .
   What hurts me is my childhood was one of extreme deprivation compared to todays kids and we learnt to make do and mend hence now in our pension years to be treated the way we are now is criminal

   Recommend (7)
6. BrokenByQE

   January 31, 2012 at 4:02 pm

   Good article on FT.com “Low Rates:The drug we can all do without” by Satyajit Das, author of ‘Extreme Money:The Masters of the Universe and the Cult of Risk’. Perhaps MK should be reading this stuff, rather than some dusty old BOE policy manual, written before the advent of computers and globalisation.

   Recommend (4)
7. Edward

   January 31, 2012 at 7:27 pm

   Keeping money under the mattress makes the effect of inflation eroding our savings event worse, as the minimal return is better than nothing. So the best thing to do if you want to keep your money in cash form is be a pro-active saver hunting out the best paying savings accounts and ideally use all of your Tax-Free ISA Allowance to soften the blow of current interest rates. Make sure you are aware of the terms and conditions specially notice/penalty for withdrawing your cash. Alan stated interest rates can only go up, so be wary of locking up savings for too long as well.

   It would be great to set up a political party for savers interest if we had proportional representation. However that would be futile with our un-democracy political system of First-Past-The-Post, as it favour the established two-party politics.

   Recommend (5)
8. Steve

   March 8, 2012 at 2:02 pm

   All I’ve heard so far is selfish views on how I with all my money in the bank I should be able to stay wealthy at the expense of everyone else . Welcome to the times are tough club . I’m afraid your no longer aloud to be lazy with your investment these days the times of sitting back on your lump sums are gone . I agree with BOE, it’s tasked with stimulating growth by all means and I’m afraid lower interest rates does this better then higher rates. how higher rates benifits the greater good I’ve heard no good argument . Even by this sites own omission it has drivin personal financial responsibity and awareness . And i bet even some savy readers have reinvested their monies for the better. Even investing in companies and therefore the economy. What kills us all is the banks drive for greed, they need to lend to businesses at low rates.

   Recommend (1)
9. frances

   March 8, 2012 at 7:59 pm

   Steve

   You are talking out the back of your head
   The very last thing any pensioner needs is a whole bunch of investments that could just as easily fail
   Share prices are a joke
   many companies even Blue Chip ones are in dire straits and you are totally ignoring the fact thar if savers had a decent return on their savings they could spend money

   As things stand Pensioners are scared stiff to buy anything more than absolute essentials ………..thats doing the economy no good at all

   You too easily forget we are the generation who went through years of impoverished childhoods , extreme prudence and frugal lives bringing up families and struggling to pay mortgages at 12% interest and now having scraped together savings for retirement because we never had the luxury of company pensions are being deliberately RIPPED OFF by both the Bof E , The Treasury and the Government

   What GB did to the Pensions Industry this lot are doing in spades to both savers and the Pension Induxtry

   Recommend (5)
10. Steve

    March 9, 2012 at 12:28 am

    So your answer Frances is to have over the future generation and not learn from history, so you can have a nice return on your savings then?
    By the way Reference the Telegragh “Sir Mervyn said that savings were effectively acting as a brake on the economy: “One of reasons for slow growth in the last year was weakness of consumer spending and higher savings by household”.and to continue -”households may want to increase the amount that they save due to other factors, such as the need to save more for future retirement provision.” ( I didn’t catch your sources of information ) —savers by thier nature do not spend . They carry on saving specially in this climate. The point is to provide disposable income in consumers current accounts not their saving accounts.
    And pensioners have never had a lot money that’s why the state is helping them out by other means .

    Anyways the BOE is showing a target of 2 % inflation this year and with a good fall in January already, many are agreeing with the trend . So looking around its possible, saving wise if the target is met early, we can find inflation beating interest rates without risk. For 2012 . I know Barnsley BS will offer 5%
    but from a well known website
    Money saving expert .com
    “Base rates are at an historic low but it’s still possible to make saving pay. The best buys pay up to 3.2% easy access, or up to 4.65% if you can lock cash away in a fixed savings ”

    Some people just need to smile a little ……:-) just think you could have had savings in Greece ………..

    Recommend (2)
11. frances

    March 9, 2012 at 9:42 am

    Sorry Steve but

    Barnsley Easy access is 2.25%
    BM Easy Access is 3.2 % minimum deposit £50K
    4% is a 3 year account

    None of those cope with the last 3 years of uncontrolled inflation wrecking the lives of those who saved for retirement or do not have an inflation linked company pension

    I very very much doubt you could live on Basic State Pension or even Pension credit ……….i know too many very frugal pensioners who are struggling like hell to do so

    The simple fact is many of us worked hard and did our bit for family or society lived very careful frugal lives and saved so we could live with dignity in retirement but the Bankers and The B of E have ripped all that away in favour of 2.99 % mortgages and huge credit card loans and replaced it with insults and meaningless platitudes

    QE is whats wrecking the economy and the power to spend

    Recommend (7)
12. John H

    March 11, 2012 at 4:08 pm

    Is the tide turning? Four institutions have now increased the cost of their standard variable rate (SVR) mortgages despite the BoE’s determination to continue with abnormal base rates. Part of this seems to be an acknowledgement of the need to offer better returns to retail depositors as in the following.

    http://www.bbc.co.uk/news/business-17314193

    Sensible mortgage payers should have factored in this possibility.

    The punishment of savers for a position we didn’t cause has continued for too far long.

    Are we seeing a de facto increase in base rates with institutions doing the work of the BoE? If so it’ll be interesting to see how long Mervyn “King Canute” will try to stop the rising waters.

    I can’t agree with Steve, quoting Mervyn King “…that savings were effectively acting as a brake on the economy.” The reason we are in such a mess is the credit binge enjoyed by feckless governments, institutions and individuals. Before that we had base rates fairer to all.

    I do indulge in a little retail therapy now and again but there’s something called “saving up for things” rather the the “I want it now” culture that has done so much damage. But with interest rates as they are I’m spending much less and no amount of cajoling by idiots like Charlie Bean with his huge salary is going to get me using my capital. Having been robbed, he now wants us to bail out the economy. You know where he can shove that.

    Give me a better return and I’ll spend more.

    Recommend (5)
13. frances

    March 13, 2012 at 12:24 am

    Sadly theres been a generation or 2 who instead of making do and mend and putting up with what they were given to furnish their house until they could actually afford it put everything on to credit cards
    add on the encouragement to keep increasing your mortgage on the basis of increasing house prices and eventually the bubble burst

    Whats so totally and utterly wrong is the MPC and idiots like Charlie Bean think that those of us who never did any of that and were always careful to live within their means and only buy what we could actually afford and then saved for our old age are being seen as ripe pickings “for the greater good ”
    Well sorry Charlie we are not fooled and we are downright bloomin angry at you and the MPC sitting in your ivory tower on mega salaries along with all the bank bosses whose bonuses make ones eyes water while ordinary decent people are being screwed

    Well it cant last and the bubble will burst and i am old enough to know a bit of history and 12% interest rates so roll on the revolution and a very very sharp lesson to all the spendthrifts out there who got us all into this mess

    Lets hope its such a big lesson they actually learn from it

    Recommend (7)
14. Howard

    March 13, 2012 at 8:59 am

    Good article in Moneyweek last week on why Low interest rates don’t spur growth. It tackles the conventional “wisdom” (if I can call it that) that we must have low interest rates to spur growth.

    The link is http://www.moneyweek.com/news-and-charts/economics/uk/low-interest-rates-dont-spur-growth-57940

    No doubt the BOE won’t be taking any notice!

    Recommend (3)
15. John.

    March 16, 2012 at 12:26 pm

    Unfortunately the link above is a subscriber only article.

    I don’t think the BoE either understand ( seriously – they’re just pulling at levers and hoping ) or care for the consequences of what they’re doing.

    Their big fear, is that interest rate hikes will trigger mortgage defaults which will trigger a housing price crash ( which is what needs to happen imho to get rid of the bloated financial belly ache in the economy ). That’s not a fear the BoE has for those families who would default, or care for their plight as they don’t give hoot about that, the fear is that the banksters and cronies putting up the usury credit stand to lose out on all the planned vast profits. Their stupidity, their problem, you might think except that banks are too big to fail apparently and so that just won’t do.

    That’s why savers are being abused and exploited, to save the hides of greedy feckless bankers and maintain the offensive upper crust, millionaire lifestyles they’re accustomed to. This idea bankers are responsible, sensible people worth the money they pay themselves is nonsense. They’re greedy thieving reptiles and borderline criminals.

    Just ask yourself who the hell is it able to obtain or get the benefit from these historic low interest rates? It certainly isn’t borrowers, businesses or savers. Who could it be?

    I personally find it difficult not to wish these monkeys some terrible fate, they’re causing untold misery for those who have done all the right things in order to bail out those who have done the all wrong things with regard to greed, usury and encouraging unsustainable debt to exploit illusory profit.

    Screw the lot of them.

    Recommend (4)