There are several commentators calling for economic orthodoxy in the FT this morning. Chris Giles for example ( no links today - I am writing in haste and on an iPad) calls for interest rates to rise now because he thinks UK employment is already below 7%, there is no excess capacity in the the economy despite an effective full time equivalent unemployment rate of well in excess of 3 million, and he is terrified of inflation.
This terror of inflation intrigues me. He celebrates the UK's new growth. He ignores the fact that it is based almost entirely on inflation of UK domestic housing prices, putting them even further out of most people's reach, and then demands that what would, in effect, be wage inflation be curtailed to make sure it stays that way.
I think we should have no doubt at all that this demand is not economic policy. This is in a sense not even political policy. Let's call it class warfare, because that it what it is. What he is demanding is that the economy be run for the benefit of the minority who do not see houses as homes but as assets, and he wants to both preserve that asset base for the benefit of the few in this situation and to ensure that those remaining owners can use their increased asset worth as the security for the debt that they owe to that same minority in society.
So we actually have a policy that picks and chooses the inflation it wants. Asset inflation they say is good; wage inflation, they say, is bad.
What this country very clearly needs is the reverse. We need real wage inflation to corrct years of stagnation in the purchasing power of ordinary people and we need asset values to fall, firstly so that people can buy property and secondly because we want a reduction in personal debt - which debt is owed to a small group in society.
So do not for a moment be confused by the demand that we must increase interest rates to beat inflation. That is not true unless the aim is to preserve wealth and income inequalities in society. I want to beat those inequalities. In that case I do want to curb inflation - but it's the inflation in asset prices and debt volume that worries me - and the FT isn't saying much on that yet. More worryingly, when it comes to policy it will be the FT's position that will be considered.
Be worried. Inflation is out to beat you, but not in the way most commentators report.
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It seems to me that the current “recovery” is built almost entirely on reflating the kind of personal debt boom that we saw in the run up to the 2008 crash. So what Chris G is really calling for is a repeat of that crash. Given that the complete collapse of the banking system was only just averted by massive govt intervention last time round, another crash would probably mean the end of the capitalist system as we know it – given that govts have far less fiscal room for manoeuvre this time round.
So it could be that Chris is an undercover Marxist calling for the overthrow of the capitalist system. Stranger things have happened at the FT!
On the monetary policy point – clearly one would have to be crackers to think that raising interest rates now is the right thing to do. But the govt is wasting the opportunity afforded by low interest rates right now – which is an ideal opportunity for govt borrowing to invest. Instead, PRIVATE borrowing is rising – which will most likely lead to another crash. Similarly, QE has pushed up asset prices rather than providing another channel for govt to fund investment for the recovery.
Powerful interpretation of where we really are.
“Be worried. Inflation is out to beat you, but not in the way most commentators report.”…… It is worryingly unsurprising, that most of said commentators depend on the ‘minority’ you allude to for their very existence.
That is the real crime that so many are going along with this economic illiteracy.
Excellent analysis Richard -this is the sort of thing the Labour (or any opposition) should be saying but won’t in our ‘one party’ system. This is not policy, it is ideology of a fascist nature in action. It is a tragedy unfolding (one that has already happened in poor old Greece).
Rising interest rates tend to *deflate* asset prices. House prices tend to go down (or their growth slow) as the necessary debt funding for them becomes more expensive. Equity prices tend to fall as the risk/return for holding them becomes less attractive in comparison to higher bond yields. The reverse is also true — low interest rates tend to make equities rally (as people look for investment returns outside interest rate markets) and house prices go up, as people find it easier to debt finance their house purchases — causing demand to increase in the housing market. As Richard correctly says, asset prices do contribute to inflation, so by raising interest rates to contain inflation one would expect real wages to increase (real wages being nominal wage increases minus inflation). As such, I can’t for a moment see how raising interest rates would “preserve weath and income inequalities”. Indeed, the evidence we have seen from the financial crisis is that super low interest rates actually serve to increase those same inequalties — there are many articles out there showing how the wealthy have benefitted most from Zero rate policies/QE — and I believe Richard has argued as much in some of his previous articles. – See more at: http://www.taxresearch.org.uk/Blog/2014/01/09/on-good-and-bad-inflation/comment-page-1/#comment-678405
Please remember the context in which I wrote, which is the relationship between interest rates and inflation and the motives for increasing rates
Don’t bond holders like higher interest rates too because it curbs inflation and preserves the value of those bonds?
Government borrowing actually lowers interest rates, but higher rates have to be factored into the bonds to compensate for expected higher inflation, or so the market demands, anyway!
@ Richard Murphy
I’m not totally sure what you are getting at. Correct me if I’m wrong, but you seem to be saying that house prices rises cause inflation (true in at least part) but then argue that raising interest rates would increase the value of homes? Higher interest will slow the increase in house prices rather than increase them. Likewise, higher rates leading to lower inflation will increase real wage growth (though has no direct effect on nominal wage growth).
I also take issue with the statement”:
“He celebrates the UK’s new growth. He ignores the fact that it is based almost entirely on inflation of UK domestic housing prices”
House prices simply don’t affect GDP in the manner Richard suggests. GDP is defined as “the market value of all godds and services prduced within a country in a given period of time”. Asset values are only important if they have increased through improvement or other work – which is why in terms of GDP it is the “construction” grouping which affects GDP growth, and not house prices themselves. Apart from that, it isn’t even the construction component which is really driving GDP growth – it is mostly from the services components of GDP. (3Q13 data from ONS: Overall +0.79%, Construction +0.15%, Services +0.59% for example).
@ Steveo!!
Bond *holders* don”t like higher rates as though they get a higher yield, it erodes the capital value of their bonds. What does happen as rates rise is that people switch from other investments to bonds as rate of return of bonds beocme more attractive when compared to the risks inherent in equities.
Government borrowing simply does not lower interest rates. It raises them as bond supply increases. Bond yields do tend to rise though as inflation expectations increase. This makes sense though, on two levels. Firstly, your real return on bonds are eroded with higher inflation, so those bonds aren’t worth as much. Hence the yields increase/prices drop to compensate. Secondly, yields rise as people expect the central bank to hike rates to curb inflation.
“Government borrowing simply does not lower interest rates. It raises them as bond supply increases. Bond yields do tend to rise though as inflation expectations increase.”
Haven’t you slightly contradicted yourself in the same sentence? The open market operations of government borrowing lowers interest rates. Compensation has to be factored into government bonds in the expectation if the higher spending setting off higher inflation. This factored-in compensation is one of the reasons for the rise in interest rates in government bonds
Inflation erodes the value of bonds just as it erodes the value of all money. That is why bond holders tend to prefer recessions to booms.
You may well find that NeoLabour are not as fond of interest staying as it is….
After all, high unemployment keeps the serfs from thinking too much.
If there is one sure thing about ConLabLib it is that you cannot fit a single atom between them, and that they are all bought people.
In any case, we are starting the run-in to the election, so interest rate rises are highly unlikely. Unless the gov think that the initial rise in resulting unemployment will not happen, or will disappear by the election.
http://mainlymacro.blogspot.co.uk/2014/01/will-mpc-raise-uk-interest-rates-in-2014.html