This morning a speech was given by Ben Broadbent of the Bank of England which touches several of the themes of this blog. One of them -falling interest-rates- is pretty much a theme of my career as whilst there have been ebbs and flows the trend has been downwards. Of course at the time it has not always felt like that and I still have vivid memories of 1992 when the UK found itself ejected from the Exchange Rate Mechanism or ERM and not only was the Base Rate moved from 10% to 12% but an additonal move to 15% was announced for the next day. Actually events were so fast moving that by then we were back to a fully floating currency and the latter rise never took place! If younger readers are bemused by the concept of 12% or 15% interest-rates let me apologise.
Let us start with the misrepresentations
Towards the end of the speech we are told this with reference to the credit crunch era.
inflation has remained broadly close to target
Perhaps Ben found the period where UK consumer inflation pushed over 5% in the autumn of 2011 so painful that he now suffers from a type of amnesia on the subject. Either that or the word broadly needs to go into my financial lexicon for these times. When you consider the extent of the impact of the credit crunch on the UK economy then the average annual official inflation figures of 3.3% for 2010 and 4.5% for 2011 look rather extraordinary to me. If we look at the Retail Price Index the average annual rate of inflation from 2010 onwards has gone 4.6%,5.2%,3.2%, and then 3% in 2013. Those who have seen their real wages drop due to this might like to wonder if Ben thinks that their wages are broadly the same.
The Excuses are next
Apparently when the Bank of England was cuting interest-rates it was just following orders or something like that!
This bears out, for me, that the real task for policy is to understand – and then adapt to – economic forces affecting the natural, or equilibrium rate of interest.
That is an interesting swerve of responsibility that I doubt we would have seen had policy been more successful. But I also have a theoretical challenge for the sentence above above which is that one thing we should have learnt from the credit crunch period is that the concept of equilibrium in economics is both bankrupt and otiose. There was no equilibrium in the pre credit crunch period and there certainly isn’t any to be found right now. Indeed even if we briefly enetered a period of it by fluke we would not know that we were there if we allow for the leads and lags of economic measurement. Let me go further I fear that it is economic models and theories pressing for their equilibrium that helped tip us over the edge.
So when the Bank of England slashed interest-rates in 2008 it was just following economic forces? As we now these days that market particpants spend their time front-running central banks can you spot the flaw in central banks responding to market particpants which are one of their measures of economic forces? That is a recipe for quite a mess,which of course is where we find ourselves.
This has become a regular theme of Bank of England speeches recently. Do you think they might be warming us up for something? The situation is summed up the the sentence below
The yield on the 10-20 year portion of the indexed gilt curve, for example, was 4% in the mid-1990s; by the end of that decade it had dropped to barely 2%; on the eve of the financial crisis, in mid-2007, it was less than 1%; today it is -0.3%.
What he is doing here is giving us a measure of real interest-rates in the UK and he is using index-linked gilts to achieve this. The fall is quite something and is a fundamental change which preceded the credit crunch.
However whilst Ben tries to tell us that the recent move is nothing to do with the Bank of England he cannot avoid the isse of Quantitative Easing which set out to reduce bond yields directly
Work at the Bank suggests that the combined effects of the various stages of QE reduced 10-year gilt yields by as much as 100bp.
Are those the same yields which are nothing to do with Bank of England policy Ben or different ones? The contradictions get worse I am afraid to say because we get told this about QE.
;As the Bank of England explained in a Quarterly Bulletin article a couple of years ago, without QE we’d have experienced higher unemployment,lower wages and lower inflation.
So we see it confirmed that if it feels it can claim something good the Bank of England is responsible for events. Nice of it to be judge and jury on itself don’t you think?
QE has not caused an increase in inequality
Ben has it a bit awkward here because of course he has just praised himself on the subject of QE so a standard disclaimer will not work. Instead we get this.
(i) interest rates are low because central banks have chosen to keep policy rates low and (ii) this has pushed up the price of risky assets, benefiting only those who happened already to own them. I’m not sure either of these is true.
Unless the credit crunch has lasted a lot longer than I have realised Ben slips in a change of timescale here.
But over the last 15 years, equities have done poorly.
I know that sometimes it feels like the credit crunch has lasted that long but the truth is that it has not managed even half that. Those of a mind more prediposed to conspiracy theories than me may be thinking that Ben has been planning some sort of catch-up for equities.
My summary of the excuses and misreprentations made by Ben Broadbank today and more generally by his central banking colleagues can be summed up by this from the Spinners.
It’s a shame….It’s a shame
What about interest-rates?
We do get a clue from this speech as shown below.
I’d say that neutral real rates are likely to stay low for some time yet – with the implication that any rises in official policy rates are likely to be “limited and gradual” – but that, eventually, as the headwinds previously highlighted by the MPC dissipate, they are likely to rise.
Now let us add in this bit below.
For a variety of reasons, and over a long period of time, this underlying rate has been driven remorselessly downwards. An official interest rate that might once have been considered inflationary is now contractionary;
You may note that interest-rate rises have been moved to some unspeciifed future date whilst the trend to wards lower interest-rates and yields is apparently ongoing.
I would like now to look at todays retail sales figures from the UK. The numbers for September exhibited both disinflation (falling prices) and deflation over the numbers for August. Some care is needed as whilst disinflation has become rather ingrained in the retail sales numbers recently there has been much . the quarterly figures remain positive in volume terms as do the annula ones. But should this be the new trend how long would the Ben Broadbent of this speech take to recommend an easing of monetary policy and Base rates? After all he would only be reflecting economic forces.
Oh and if we link to today’s news a possible turn downwards in retail sales is about the last thing that Tesco needs right now.