Does raising base rates really reduce inflation?

[dealtn]

B) It's time to stop the rises and have a re-think as they really biting hard now into people's finances and no-one can explain the mechanism by which the rate rises are supposed to be reducing fuel-cost-driven inflation.

Firstly the main transmission mechanism isn't to tackle fuel-cost driven inflation (even if such a thing existed). But even then taking £s out of peoples pockets limits discretionary spending. Even for goods with poor elasticity of demand to price effects will have some impact on expenditure, even if less so than on other areas of spending.

It literally isn't the case that noone can explain the mechanism. It is extremely well known and available to any inquisitive reader of even the most basic economics text book.

[dealtn]

They absolutely don't have to seek the permission or approval of the government. On what evidence? I have literally discussed this mechanism with both governors and past members of the MPC.

The government of the day can make whatever legislation it wishes, subject to the will of parliament. Where have I suggested otherwise there is "no way" for them not to take it back? Such a move however would have consequences. Surely your memory isn't too short when unconventional fiscal policy was experimented with by Truss and Kwarteng. Do you believe an adoption of an unconventional monetary policy would have little impact on the markets and associated market interest and fx rates?

So which bit of what I suggested is wrong then?

The bit where you said they require the permission and approval to change monetary policy

Can the government take back control of interest rates, or not?

Yes, as I have explained.

If yes, then the BoE autonomy is an illusion.

No it isn't. The government could reduce the speed limit on the motorways to 50mph, for instance, yet your current driving on them at 70 mph is neither an illusion, nor illegal.

[Tedx]

The BOE is an arm of the government. To suggest otherwise is ridiculous.

[Lanark]

Part of the reason that rate rises are not 'working' is that so many people are in fixed rate contracts.

5 Year Fix mortgages
PCP deals where the interest rate has been hedged on the market for the duration of the contract.

So the BOE can raise rates to the moon and a majority of people will be completely unaffected, until... eventually... their deal runs out.
The result is that to have a real effect on inflation the BOE need to apply more pain for longer, than if none of these contracts existed.

[Tedx]

The government could do a better job through taxation.

It still doesn't make any more gas though.

[dealtn]

The BOE is an arm of the government. To suggest otherwise is ridiculous.

Well I disagree, as does the constitution and the legal system.

Regardless, it isn't the BoE that determines interest rates anyway!

[dealtn]

The government could do a better job through taxation.

It still doesn't make any more gas though.

And making more gas does what to control inflation? Gas makes a small impact on inflation. Even more it is falling in price at the time when prices are rising, hence inflation.

It isn't the governments job to make more gas, nor is it the MPCs.

[dealtn]

Part of the reason that rate rises are not 'working' is that so many people are in fixed rate contracts.

5 Year Fix mortgages
PCP deals where the interest rate has been hedged on the market for the duration of the contract.

So the BOE can raise rates to the moon and a majority of people will be completely unaffected, until... eventually... their deal runs out.
The result is that to have a real effect on inflation the BOE need to apply more pain for longer, than if none of these contracts existed.

True to an extent, but the target the MPC (again not the BOE!) has is effectively one that is the inflation rate in 2 year's time, which is not far from the average length of a fixed rate mortgage contract.

[servodude]

The government could do a better job through taxation.

It still doesn't make any more gas though.

And making more gas does what to control inflation? Gas makes a small impact on inflation.

Indeed. Hence using base rates as the control mechanism in response to a step change in gas cost and its subsequent follow on effects (electricity pricing, cost of manufacture for anything that uses electricity, travel costs) hardly seems optimal.
You'd have been better off taking out the effect of the transient disturbance at source rather than allowing it to propagate. That is extremely well known and available to any inquisitive reader of even the most basic control text book (e.g. Dorf or Ogata).

[NeilW]

Can the government take back control of interest rates, or not?

If yes, then the BoE autonomy is an illusion.

s11 of the Bank of England Act 1998 defines the Bank's objectives which is to maintain Price Stability and subject to that support the economic policy of HMG.

s12 gives the Treasury power to define what price stability means. If the Treasury defines price stability as '£100 of money in a year's time costs £100 today', then the Bank will be required to drop interest rates to zero.

Treasury reserve powers in s19 allow the Treasury to direct monetary policy in 'extreme economic circumstances'.

In all other cases the Bank of England Act 1946 gives Treasury the power to direct the Bank, and the Bank the power to direct other banks.

The changes to s13 and s15 of the Exchequer and Audit Department Act 1866 made by the Government Resources and Accounts Act 2000 trump the 1998 act by virtue of the doctrine of implied repeal. Those clauses give the Treasury the power to direct the Bank to make payments. There is no capacity for the Bank to refuse. Therefore the quantity of money is ultimately in the hands of Treasury, not the Bank.

Of course the Bank and Treasury work hand in glove anyway, and Parliament can rewrite any of these rules any time it wants. Parliamentary business is controlled by government and 'money bills' cannot be stopped by the House of Lords thanks to the Parliament Act.

In other words, the whole thing is an elaborate charade. It has little or no control effect except in the minds of a few true believers.

The actual function of interest rate changes is to maintain the income share of debt owners who hold to maturity.

[GoSeigen]

1. Yes ultimately the parliament and government can alter the operation of the MPC or even take control of monetary policy, but
2. Policy and practice of all major parties and all governments for 25 years has been to allow independence of the MPC to make its own decisions within its remit.
3. Everyone knows and acknowledges that monetary policy acts with a lag (for various reasons), to imply otherwise is disingenuous.
4. The UK has for a long time favoured free market mechanisms so a. direct control by government of [gas] prices or sectors of the economy are anathema b. the MPC feels the pressures of the market far more than those of government (IMO).


GS

[GoSeigen]

Indeed. Hence using base rates as the control mechanism [...]

40 years of monetarist orthodoxy. See Milton Friedman "Inflation is..."


GS

[servodude]

Indeed. Hence using base rates as the control mechanism [...]

40 years of monetarist orthodoxy. See Milton Friedman "Inflation is..."


GS

Like the monkeys, hose pipe, ladder and banana story?

Moderator Message:
This example is a fairly frivolous one, with a moral that is not altogether clear or relevant (at least, to me). Such non-obvious posts are perhaps best avoided. -- MDW1954

[Urbandreamer]

The government could do a better job through taxation.

It still doesn't make any more gas though.

I take it that you have not been following government actions.

They have put a "wind fall" tax upon the likes of wind, nuclear and yes oil and gas.
Tax: https://www.energylivenews.com/2023/01/ ... dfall-tax/
However the oil and gas companies can offset the tax by investments in new production.
Tax Subsidy: https://www.fitchratings.com/research/c ... 30-05-2022

Hence the government has done what it can to increase the gas supply and discourage investment in renewable and nuclear energy.

I personally don't think those actions as a "better job". I'd see ramping up a transition away form gas as a better job. But even I can't argue that you are right about the government not doing what it can about tax and increasing gas production.

There is a phrase that the cure for high prices is.. high prices. However I seriously question the extent that energy and food prices are the entire problem. Huge efforts have been made to use less gas or use it wisely. The wholesale price has been falling as a result.The BOE looks at "core inflation", which strips out energy and food. Headline inflation has fallen a bit recently (though food inflation is still high).
Core inflation is still rising. Personally I believe that to have something to do with the very significant recent increases in the money supply.

[Lanark]

In the 200 years that the UK has been using gas power, the country has got used to the distinctive sight of "gasometers".
These gas holders have stored coal gas (town gas) and later natural gas for the UK's urban areas, but now all but a handful are obsolete (2015).

A Gasometer (or Gas holder) is a large metal tank where gas is stored before being distributed through pipes to consumers. Gas holders were originally used for balancing the daily demand of manufactured gaseous fuels.

With the move to  natural gas  and the creation of the  national grid network, their use has steadily declined as the pipe network can store gas under pressure, and has been able to satisfy peak demand directly. This deemed the use of gasometers redundant.

The UK’s stores now hold enough gas to meet the demand of four to five winter days, or just 1% of Europe’s total available storage. The Netherlands has capacity more than nine times the UK’s, while Germany’s is 16 times the size.

The Rough storage facility, owned by Centrica, the parent company of British Gas, provided 70% of the UK gas storage capacity for more than 30 years before it shut in 2017 following a government decision not to subsidise the costly maintenance and upgrades needed to keep the site going.

It is a great irony that all this capacity was shut down and the land sold off for development, just before the recent energy crunch. But who could have predicted that a non-renewable resource would ever be subject to shortages?

[tjh290633]

In the 200 years that the UK has been using gas power, the country has got used to the distinctive sight of "gasometers".
These gas holders have stored coal gas (town gas) and later natural gas for the UK's urban areas, but now all but a handful are obsolete (2015).

Many years ago I worked on a plant at Meadowhall Gasworks in Sheffield. That site had two enormous gasholders and the supply in the area came from retorts and coke oven gas, supplemented by water gas, producer gas and oil gasification to meet the peak load.

The method of operation was to shut down the peak load units on Friday, so the the gasholders were virtually empty and were filled with coke oven gas over the weekend. Then on Monday morning the peak load plants were brought on line to meet the industrial demand.

The gasholders had water seals, and that limited the pressure that they could take. Come natural gas and pressure rose much higher, so excess gas could be stored in the trunk pipeline or in a basin like Rough. The decision to close Rough was very shortsighted.

TJH

[Lanark]

Rough reopened last winter, at 20% capacity taking our storage up to 9 days.
https://www.centrica.com/media-centre/n ... -facility/

[scotview]

With regard to the medium term interest rate outlook, a cold winter will see inflation increase with substantial increases in energy prices.

So, in my book raising or lowering interest rates over the next 9 months is irrelevant compared to what mother nature is going to do this winter.

[Mike4]

With regard to the medium term interest rate outlook, a cold winter will see inflation increase with substantial increases in energy prices.

So, in my book raising or lowering interest rates over the next 9 months is irrelevant compared to what mother nature is going to do this winter.

And this is a feedback mechanism anyway. Energy prices rise, mopping up spending power in the same way as raising interest rates. No need to do both, surely.

[GoSeigen]

With regard to the medium term interest rate outlook, a cold winter will see inflation increase with substantial increases in energy prices.

So, in my book raising or lowering interest rates over the next 9 months is irrelevant compared to what mother nature is going to do this winter.

And this is a feedback mechanism anyway. Energy prices rise, mopping up spending power in the same way as raising interest rates. No need to do both, surely.

Cart before the horse. Energy prices rise because there is consumer spending power. Interest rate rises drain the liquidity.

GS