{"id":41852,"date":"2018-05-15T09:11:47","date_gmt":"2018-05-15T08:11:47","guid":{"rendered":"http:\/\/www.taxresearch.org.uk\/Blog\/?p=41852"},"modified":"2018-05-15T09:11:48","modified_gmt":"2018-05-15T08:11:48","slug":"the-death-of-interest-inflation-and-the-independent-central-bank","status":"publish","type":"post","link":"https:\/\/www.taxresearch.org.uk\/Blog\/2018\/05\/15\/the-death-of-interest-inflation-and-the-independent-central-bank\/","title":{"rendered":"The death of interest, inflation and the independent central bank"},"content":{"rendered":"

I have used this chart before, and I do so again without apology. It comes from an IPPR report<\/a>, but that's\u00a0 irrelevant to the use that I'm making of it:<\/p>\n

\"\"<\/a><\/p>\n

What, I suggest, is that this chart shows something quite staggering. I call it the death of\u00a0interest. The trend is long-term and inexorable,\u00a0 in my opinion.\u00a0 The simple fact is that the so-called 'risk-free'\u00a0 interest rate is disappearing.<\/p>\n

I stress, this does not mean that interest will not be charged in the future,\u00a0 but to understand this it has to be appreciated that the interest rate charged on most loans is made up of two components.\u00a0 One is the cost of money,\u00a0 and since for most banks\u00a0the cost of money is little different to the 'risk-free'\u00a0 interest rate this charge is tending towards zero over time. That's\u00a0precisely because, as modern monetary theory explains, there is no cost to creating money and as a consequence\u00a0there is no cost to lending it, meaning that its price should, in fact, be nothing.\u00a0 That is a\u00a0 fundamental reason why, overall, interest rates remain low now, on average, when compared to long-term norms when different money creation arrangements prevailed.<\/p>\n

The second component is not really an interest charge at all: it is a risk premium to cover the chance that the borrower will default upon their loan obligation, and leave the lender with a bad debt.\u00a0 This is, of course, why many loans still carry quite exceptional interest rates when official rates are almost non-existent.<\/p>\n

I am not,\u00a0 then, suggesting that we will see the disappearance of interest in the economy:\u00a0 as long as default risk exists there will be interest charges,\u00a0 but that is not the point at issue here. All that disguises is the fact that the real, risk-free,\u00a0 interest rate is tending towards nothing and that means that, in effect, the entire mechanism of monetary policy is now redundant.<\/p>\n

There is another reason for this redundancy: if interest rates decline so does inflationary risk. This is a chart of long-term\u00a0inflation in the UK<\/a>, from the House of Commons library:<\/p>\n

\"\"<\/a><\/p>\n

The risk-free interest rate\u00a0is declining in the UK\u00a0 and wholly unsurprisingly so too are oscillations in inflation rates,\u00a0 especially if war and the world crashing out of the gold standard and the UK leaving other exchange rate mechanisms (such as the ERM) are taken out of the trend,\u00a0 they being the only real explanation for significant inflation hikes since the 1860s.<\/p>\n

I have already suggested today<\/a> that monetary policy now seems to be a wholly irrelevant mechanism for economic policy control, but so too, I suggest is\u00a0 inflation targeting. The reason is common between two:\u00a0 if interest rates are tending toward zero, and I think they are,\u00a0 then inflation is inevitably going to tend in the same direction,\u00a0 external shocks apart, which can never be corrected by monetary policy.<\/p>\n

The time to bury monetarism really has arrived. And in that case\u00a0 the day of the independent central bank is also over.<\/p>\n","protected":false},"excerpt":{"rendered":"

I have used this chart before, and I do so again without apology. It comes from an IPPR report, but that’s\u00a0 irrelevant to the use
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