Interest-Rate cuts are not always an economic stimulus

It is one of the themes of this blog that official interest-rate cuts do not always have a beneficial impact on the economy. To be specific once we go below a range around 1.5% to 2% the effect fades and dies in my opinion. That of course is a critique of those at the Bank of England who want to cut Bank Rate further such as Governor Mark Carney and even more so of the “muscular easing” proposed by its Chief Economist Andy Haldane. Overall the latest official minutes told us this.

To that end, most members of the Committee expect monetary policy to be loosened in August.

However someone who I have praised in the past for at least doing some thinking is Kristin Forbes at the Bank of England. She has demonstrated this again overnight in an article published in the Daily Telegraph. This makes its point starting with the headline.

Wait for Brexit fog to clear before interest rate cut

She even evokes the World War 2 message of Keep Calm and Carry On as she points out this.

The largest price movements have since moderated. Sterling has recovered one quarter of its post-referendum fall. Most major global stock markets (including the FTSE) are now higher than before the vote.

In the real economy she points out that contrary to past Bank of England rhetoric there was an apparent pick-up in the economy in the second quarter of this year.

And complicating any assessment, the economy was quite solid before the vote. May forecasts predicted growth in the second quarter would slow to 0.3pc, but the latest data suggest it strengthened to double that.

It is hard not to have a wry smile at the fact that many of those who are so sure of the future right now have just got their forecasts wrong again. Some humility please. Kristin sees a two-way pull on the economy.

Uncertainty may cause businesses to delay hiring and major new projects. Sectors that involve long-term commitments or major expenses—such as commercial real estate and housing—will undoubtedly be hurt……..Some companies could also benefit—such as exporters who gain from sterling’s depreciation.

Indeed we also get a critique of the panicky response at times exhibited by Governor Carney and indeed Andy Haldane.

This is not 2008. Then markets were collapsing, the financial system stopped functioning, and the global economy was entering a recession. This is not a “Lehman moment”.

The case against a Bank Rate cut

We are reminded that there are costs to monetary easing and not just benefits.

Unfortunately, easing monetary policy not only has benefits, but also costs.

Two are very familiar on here. There is an individual impact.

People will earn less on their hard-earned savings—potentially cutting back on spending to reach a target savings pot.

Also there is a corporate impact.

Pension and life insurance funds will have a harder time meeting their commitments. Companies may need to put more money into pension schemes—leaving less to spend on workers and investment.

It is way past time to change the rules on final salary schemes as for a start negative yields will blow them up. However when I press for this all I get is silence. The sort of silence I got when I pointed out that negative interest-rates were coming or that the Bank of England was more likely to cut than raise next.

Also of course every central banker worries about “the precious”.

Banks will make less money on lending—potentially making it harder for consumers and businesses to get loans.

You may note that the worry about the banks is dressed up as being a worry about the rest of us. Actually this is one area where I differ with Kristin. The latter bit about loan availability may or may not happen but in Sweden the banks have used negative interest-rates as an opportunity to widen margins in some cases to record levels I believe. “The precious” remains rather good at looking after itself.

There is also the cost from likely higher inflation as I discussed only on Tuesday. Here is Kristin’s estimate.

Historical relationships suggest sterling’s 15pc depreciation from its recent high will increase the price level by 2.5pc.

The 15% statement is slightly odd as you see the chart she has agrees with the 10% fall I have used. So on a like for like basis I would have suggested a 1.5% rise in inflation or she would suggest 1.7% on my basis.

We get a reminder that the Bank of England is supposed to support economic demand whilst aiming for the inflation target.

We face a trade off between supporting demand and our inflation target.

Retail Sales

These emerge with interesting timing after the way that Ms Forbes pointed out that consumers behaviour was going to be very important looking forwards.

Since consumer spending is over 60pc of total demand, this will provide an important support to the economy if it continues.

We found out that annual and quarterly growth remains strong.

The volume of retail sales in June 2016 is estimated to have increased by 4.3% compared with June 2015…….The underlying pattern in the quantity bought, as suggested by the 3 month on 3 month movement, increased by 1.6%….There has been sustained growth, spanning 31 months in the 3 month on 3 month movement in the quantity bought: the longest period of growth since records began in June 1996.

However there was a month on month fall.

Compared with May 2016, the quantity bought in the retail industry is estimated to have decreased by 0.9%.

This is already being presented as “the end of the world as we know it” in some quarters but if they bothered to read to the end of the report they would have seen this.

The largest downwards contribution for both quantity bought and amount spent came from food stores.

Whereas a Brexit dip would presumably be in discretionary spending categories. Also some of it was a pre-existing trend and let me put on sackcloth and ashes for mentioning the weather in an economic context.

According to the British Retail Consortium, there was a decline in sales in the fashion categories, especially in women’s fashion and footwear, following one of the wettest starts to a UK summer since records began.

Public Finances

We use these as a guide to economic health in the sense of how much a government gets in revenue and receipts is another type of insight into the economy. We start with some positive news.

Public sector net borrowing (excluding public sector banks) decreased by £2.2 billion to £7.8 billion in June 2016, compared with June 2015.

Hopeful and some of the better news was driven by this.

Income Tax-related payments increased by £0.7 billion, or 6.3%, to £12.2 billion.

Some care is needed as in the previous two months it had disappointed. Oh and another theme of this website popped up.

debt interest in June 2016 decreased by £0.8 billion, or 19.0%,

Whilst our national debt continues to rise Gilt yields have fallen heavily and combined with lower RPI inflation have more than offset it.


This is a welcome and in some senses overdue intervention from Kristin Forbes on the impact of official interest-rate cuts and monetary easing. Back on July 1st I pointed out that her past speeches were likely to lead her to such a view. This clearly begs a question as to whether in reality she signed up to the claims and rhetoric of Governor Carney. Meanwhile the Bank of England’s Chief Economist has been on BBC Radio 4.

“Low rates & large asset purchases can stimulate prices of risky assets, encourage risk taking”

“Little evidence of bubbles since financial crisis”

I do hope that he was not telling us there is no evidence of bubbles from Central London! Oh and aren’t those two sentences contradictions in terms? Was he to be found bopping to disco queen Kim Syms in his youth?

Too blind to see it
Too blind to see what you were doing
Too blind to see it
Too blind to see what you were doing

Anyway there are other central bankers in the news as we look east to Nihon. From Francine Lacqua.

Kuroda Says No Need and No Possibility for Helicopter Money

What happened last time he denied something 8 days before a Bank of Japan meeting?




14 thoughts on “Interest-Rate cuts are not always an economic stimulus

  1. Great blog as always, Shaun, and thank you for pointing us towards Kristin Forbes’s op-ed.
    I noticed that she says in the beginning of her speech: “Sterling experienced its sharpest two-day fall ever”. So it was worse than the fall after Black Wednesday in September 1992 when the UK dropped out of the European Exchange Rate Mechanism. Given that, it took a lot of chutzpah for Carney to tell the Treasury Select Committee on July 12: “Things have changed. We don’t keep things under wraps. We don’t look to have exchange rate crises, we look to have exchange rate adjustments.” This was an obvious rebuke directed against Norman Lamont. Of the four people who signed a Telegraph op-ed attacking the Bank of England for scaremongering he chose to attack the Chancellor of the Exchequer who changed the remit of the Bank of England to create the inflation targeting regime under which Carney operates. This was very odd, since the link between Black Wednesday and the new monetary policy regime was direct. Since the Bank of England could no longer target the Deutschmark, Mr. Lamont decided it should target RPIX.
    Andrew Tyrie isn’t the sharpest tool in the shed, or he might have asked Carney what he would have done differently if he had been running the UK economy in 1992 instead of duffers (in Carney’s view) like Lamont and Steady Eddie George. Would he have taken the UK into the euro? Because that was certainly the path it was on before Black Wednesday; the ERM was just a lead-up to launching the euro.

    • Hi Andrew and thanks

      I still remember 1992 and the run-up to it. Maybe the UK economy could have survived the effort to maintain a value of 3 Deutschemarks to the £ but it could not do so as the Bundesbank was pushing the DM higher. We were not the only country being squeezed ( Italy for example was too) but we came under pressure and were forced out of the ERM. Another difference to add to your list was the large amount of foreign exchange intervention made by the Bank of England in a futile effort to resist meaning that in this occassion the Borg were correct.

      So I agree Carney was misleading and there is a bigger omission which is of course we do not have an exchange rate target now.

      In a coincidence I am off to meet a friend and ex-colleague later who suffered that day. In business terms it was going fine as he had bought UK Pound £ put options and was anticipating making large profits. Instead his boss fired him so that the position became his 😦

  2. Hi Shaun

    There are two issues here that I find interesting.

    I think the BOE always have an implicit GDP growth target in mind when they look at supporting demand but I think that the demographic changes and the insipid productivity growth means that a realistic growth target is significantly lower than that assumed and that they are targeting a false position. Furthermore, as far as demographics are concerned we are only at the foothills of the changes we will experience over the next twenty or thirty years; this is not a cyclical issue.

    The second thing is that we do not seem to be in danger of an old fashioned wage/price spiral as we had so often in the sixties and seventies. Although this may enable the BOE to “look through” any exchange rate generated inflation in the absence of secondary effects it does nevertheless ratchet the inflation index up over time and this is acting as a stealth impoverishment of the population and must compound the structural factors I have mentioned above.

    • Hi Bob J

      There were a lot of rumours about a 5% per annum target for nominal GDP post credit crunch and the evidence did seem to back it up. Of course there was a misfire in 2011 when consumer inflation went above 5%, whilst that is far from being the only component of the GDP deflator it did illustrate the problem if your 5% turns out to be inflation! Also there is currently the Irish issue which has a deflator of 5% (okay 4.9%) but apparently no inflation…

      I agree completely that rather than absolute inflation levels it is real wages which are the key.

  3. ‘It is way past time to change the rules on final salary schemes as for a start negative yields will blow them up. ‘

    Quite,Reflecting a relevant concern of Paul Hodges as well.

    ‘Around a quarter of global bonds now have negative interest rates. This means that you get less money back at maturity than you originally invested. And the number of bonds impacted is rising exponentially, as Bank of America Merrill Lynch reports:

    $13tn of global debt has negative yields, compared to $11tn before the Brexit vote, and none just 2 years ago
    You will receive a negative interest rate on Swiss bonds even if you commit your money for the next 50 years
    $250bn of euro-denominated corporate bonds are now trading at negative yields
    Even Italy, in the middle of a banking crisis, offers negative yields on $1.6tn of government bonds’

    • So how would you feel if, following the same rules, your life insurance company says that, instead of paying out £200k upon your demise, your policy, to which you have been paying premiums for 30 years, will now pay out £10k, because it’s precisely the same?

  4. Interesting as well Shaun that you point to evidence of Swedish banks achieving wider margins on negative rates.I had thought the evidence was clear that lower rates impacted margins adversely?

    Obviously,like Kirsten,I’m deeply worried that the banks will no longer be able to get people deep into debt to get us out of the mess we’re in.

    • Hi Dutch

      Thanks for the pension link above, final salary schemes are being forced between a rock and a hard place. As to Sweden yes I remember being shown a chart which showed margins being squeezed as negative interest-rates arrived but them marching them wider again as they adjusted to the new reality.

  5. At the risk of invoking Steve Priest once again, it really is a case that these bankers do not know what to do – but essentially because they do not really know what they are trying to achieve – perhaps a word from Bono might help:

    “I have run, I have crawled
    I have scaled these city walls
    These city walls
    Only to be with you.

    But I still haven’t found
    What I’m looking for.
    But I still haven’t found
    What I’m looking for.”

    Although supposed independence was only granted to the BoE in 97, political interference has also always been present. Back in 1988, which was the first really big crash caused by cheap and freely available money/credit, it was straightforward – the clown Lawson had pumped up a bubble with low rates, inflation took off and up went rates; when the economy stalled, rates were reduced and economic growth picked up. This was easy because a 1% cut was feasible and made a big difference to spending power, especially because rates were far above the real UK liquidity trap level of about 4% (the point at which spare cash disappears into assets). Since inflation was tamed with more sensible monetary policy and the move to the euro (I see the Brexiters still denounce it forgetting that it was gbp1= e1.60 on day 1 and is now e1.20), lower inflation has brought lower rates, but when the cheap money exploded again after the 2001 AQ attacks (Bin laden having said he would wreck the West economically), inflation began its rise again, but rates were around the liquidity trap level and so, could not could not have much effect – indeed, it only took rises of about 1% around the world in late 2007 to “total” the world economic situation.

    The problem stems really from different central banks having different remits: the Bundesbank has always been about inflationary discipline to produce certainty and stability – the BoE has had a notional inflation target since 1997, but that was after a culture of doing government will. The BoE has been infected by that strange idea that “boom and bust” has been conquered and so, monetary policy can “manage” it to a more level progression – this has given way to ignoring the inconvenient in a groupthink that focuses solely on GDP growth. That raises another issue – if you go right back to the 1950s, you will see that UK growth only exceeded growth in Germany in periods of loose monetary policy. The idea grew up that house prices rises demonstrated growing wealth, which would then work its way into consumption growth as people borrowed against their asset wealth.

    Consequently, having cut rates below the liquidity trap level, BoE policy had nowhere to go, precisely because of the “real inflation” fiddle. As even RPI inflation touched 5% in 2011, it should have provoked a rate move, but of course house prices were actually still slightly on the slide at that point – growth had evaporated and Gideon’s budget plans were based on a doubling of household debt over the first Conservative-led Parliament. Inflation was ignored – even though the oil price threatened some upward pressure – as the pressure was now on Carney to raise GDP – he opted for the usual way: loose policy to raise asset prices. How then was he to measure the success of the economic recovery (we are now 8 years on from Lehmans)? Unemployment seemed like a good measure – a growing economy should produce more jobs – hence the 7% “forward guidance” – it does of course now stand at 4.5% and there is talk of a rate cut, even after the recent devaluation of the GBP effectively reduced rates by 2%.

    This is compounded by the rate level – once you are down below 2%, changes are usually only in the 0.25% area, because of the relative effect on the interest component – at say 8%, 1% has the same ratio effect, but 4x the actual money impact.

    Unable to read the signals or even define what he is aiming for, Carney does not know where he is going. We have sat in the liquidity trap (cue Elvis!) since 2009 and while the BoE likes to pretend it is bringing growth back, it is just producing an inefficient economy, full of fake jobs, where productivity has hardly shifted in 10 years (hence the dumping of the 7% forward guidance).

    Forbes merely demonstrates the litany of failures to know what they are doing at the BoE “Most major global stock markets (including the FTSE) are now higher than before the vote.” – yes, love, because more cheap money is being predicted and the flight to the ultimate safe havens of the USD and JPY have made GBP-priced assets rise!

    It is monumentally stupid and we have perhaps moved from Steve Priest via Bono to Elvis and back to Steve again. Time perhaps for Imagination “It’s just an illusion”.

    • Central bankers can’t fix everything, it is the politicians who keep borrowing in a claimed recovery. What happens if liquidity dries up and the currency freefalls?

      • If you raise rates, people like Eric’s friend will spend more,as they will feel they do not have to save more, enhancing consumption demand (and hence GDP) while also supporting the currency. When rates are so low, people save more, which is another reason why rate cuts from existing low levels do not stimulate an economy.

    • Hello, David. You write: “the BoE has had a notional inflation target since 1997”. The Bank of England became an inflation targeting central bank on October 9, 1992, did it not? Maybe it was not an independent central bank then but the Bank pretty much respected the targets that were established over the 1993 to 1997 period.

  6. Lewis Carroll, more or less, helps us out:
    Mad Hatter: Would you like a little more tea?
    Alice: Well, I haven’t had any yet, so I can’t very well take more.
    March Hare: Ah, you mean you can’t very well take less.
    Mad Hatter: Yes. You can always take more than nothing.
    A friend told me this week that the interest rate on his building society account was to be cut soon. So he’s depositing more readies in order to take full advantage of his tax free interest allowance.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s