Rates of Interest

Do you agree that higher interest rates will reduce demand and output/employment? Simon Wren-Lewis asked in this recent twitter feed. (Itself a rich source of all sorts of education!)

I replied perhaps, possibly. And I’m beginning to wonder if even that was much too certain….

For a start, since the interest rate on my credit card is pushing 20% and the Bank of England ‘bank rate’ is 0.75%, I’m really not sure the bank rate is, individually, of much consequence.

For small business it might be, but we know there is precious little small business bank lending going on – it is mostly mortgages, or loans to the financial sector itself.

(Data from the BoE is the most up to date I can find.)

Does a change in interest rate really have the desired effect? I can see it might actually make investment less likely – because it could become too expensive. So that could well mean you actually employ more people. The expenses are day to day and if the employees are zero hours or temporary you can actually put all the risk onto your employees – what joy! Any major capital expenditure needs paying for, always, until finally paid for. People, do not.

And with so much borrowing currently required in order to live our lives at all, then what we might be engendering is not reduced demand or employment but actually increased poverty. Indeed privatisation of anything is generally based on borrowing so, as we have seen with Carillion and Interserve this is not a safe way of providing services, so even at a government level, increased interest rates are beneficial to no-one but the financiers.

Interest rates are, by definition, always paid by those who have insufficient money to those who have enough. So interest is always a method of enriching those who have. Why Simon Wren-Lewis, as someone sympathetic to Labour, thinks this is such a good idea I struggle to understand.

He goes on about interest rates at ‘the lower bound’, Why doesn’t he therefore start to think about a demurrage system like that with the Wörgl scrip currency, designed to increase the velocity of money? That would have been properly radical, but, Oxford academic that he is, this seems to be consigned to the too difficult category and he proposes just a simple ‘financial adjustment’ of interest rates. An interest rate increase looks a lot more dangerous and possibly life changing when seen through the lense of real life.

Oh for humanity first.

And economic theory last.

Comments

  1. Peter Dawe -

    You left out the matter that rich people do not invest in “bank rate” deposits. Only poorer people use deposit account at 0.5%. Indeed, poor people are banned from high interest rates as they are characterised as higher risk, when patently they are not.

  2. Peter May -

    Are they? I thought if you had the money you could invest it as you wished?

  3. Bill Hughes -

    Poorer people are forced to pay higher interest whether with Wonga (as was) or similar loan sharks or ordinary credit cards usually 20%+.. Better off people can get bank loans at lower interest rates and the super rich can get lower rates still. It is true that the bank rate of 0.75% is not really relevant to most people’s borrowing requirements.

  4. Neil Robertson -

    Hi Peter, I think it will be very difficult to increase interest rates significantly without causing an awful lot of pain. Their current level has ended up being reflected in the value of property and the size of average mortgages. The fact that a lot of people are on fixed rates delays the impact, but mortgages are one area where people are significantly impacted by changes in the base rate.

  5. Andrew (Andy) Crow -

    I’d got the impression that the real damage increased interest rates will do is to make a lot of large companies bankrupt as they try to roll-over their ‘leverage’ at higher rates.

    Quite a lot of speculators are betting large amounts of money on the Collapse of over-leveraged US corporations, which have taken advantage of recently historic low levels of interest to artificially inflate their short-term profitability. These are the sort of borrowers who the base rate matters to.

    The real killer is the knock-on effect of redundancies, in an already precarious consumer debt mountain. That becomes a double whammy. Make that triple if much of the consumer debt is well below ‘prime’ by now.

    Tinkering with interest rates won’t defuse the debt time bomb, I suggest. It will take a radical shift in taxation policies and I’m betting on the next major global crash happening before that is even accepted, let alone begins to be enforced.

    The wealthy neoliberals’ trope that ‘Tax is baad’ dominates the opinion even of the mass of the population that would benefit from constructive tax reforms. And a lot of that would have to be in the form of taxation on financial transactions; so many of which are zero sum exchanges and totally unproductive in real terms.

    It’s not going to happen is it ?

  6. Peter May -

    I think most large companies can either borrow bonds or have a stack of cash. smaller ones are potentially vulnerable, I agree.
    Quite right too about the private debt which seems to be providing much of the demand in the economy. DFS still rent sofas!

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