Why the last thing we’re going to need is interest rate rises

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I have already mentioned this morning the concern that Danny Blanchflower and I share that so many economists appear incredibly keen that interest rates in the UK be increased by the Bank of England.

There is only one reason for increasing interest rates. That is to reduce inflation.

Inflation comes in three forms. The first is produced by rampant demand that is driving prices upward. Raising rates can have an impact on this, with a very long lag involved because so many mortgages are fixed rate. The policy hits those on low incomes and who are younger the most as they are most likely to borrow. It is a blunt and regressive economic instrument that massively favours the well off.

The second cause is supply chain blockages, creating a supply shortage, pushing inflation up as prices rise in response. These problems are solved by sorting out the supply chain blockage, and not by raising rates, which may well exacerbate the supply chain problem by reducing investment.

Third, inflation is caused by exchange rate shocks, all of which in recent years have been domestically generated, largely around Brexit. The solution here is to get the politics right, and not increase rates, which never solves such issues.

The UK has very small risk of supply chain and politically induced inflation right now, but none at all of demand induced inflation. As Larry Elliott noted in the Guardian yesterday, ONS data shows that the recovery is losing momentum:

Card payments: flat. The number of seated diners: flat. Retail footfall: down slightly. Ship visits to the UK: down slightly. Daily flights: up a bit.

And on top of that 7% of UK employees are still furloughed and that scheme has a month to go. We face a massive unemployment hike that no one still seems to want to talk about.

And, as every serious epidemiologist I read agrees, the risk of Covid becoming rampant again this autumn is now massive. We are in for another period of inaction before lockdown has to happen again to protect the NHS, probably too late to save the lives of a great many people.

So where is the rampant demand, which is the only sort of inflation increasing interest rates can save us from going to come from? Precisely nowhere, of course.

And so why are so many economists demanding interest rate rises? That’s a good question, and is why Danny and I are asking in whose interests these people promoting rate increases are talking, because it is certainly not for the ordinary person in the UK, for whom rate rises will be disastrous. They will also be disastrous for the economy as a whole in due course as the knock on effects lead to property price falls, negative equity, a banking crisis, bailouts and so to recession. Isn’t it fair to ask why some economists might want that? Doesn’t wishing the worst for the economy and country require some explanation? We think so.