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Does raising base rates really reduce inflation?
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- Lemon Half
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Does raising base rates really reduce inflation?
Someone on the R5 this morning made the point that swims around in my own mind much of the time. Probably rather banal to the economists in here but to me, it seems that raising base rates in response to rising prices just twists the knife and causes more price rises. So they raise them again, adding to business overheads across the board which all gets loaded into higher retail prices again.
I understand the point of mopping up excess demand for goods and services but surely the massive rises in fuel costs are the cause of inflation at the moment, not too much cash chasing too few goods and services.
On the other hand I seem to remember President Erdoğan refusing to raise interest rates in Turkey in response to spiralling inflation and recently giving up that policy, admitting it hasn't worked....
I understand the point of mopping up excess demand for goods and services but surely the massive rises in fuel costs are the cause of inflation at the moment, not too much cash chasing too few goods and services.
On the other hand I seem to remember President Erdoğan refusing to raise interest rates in Turkey in response to spiralling inflation and recently giving up that policy, admitting it hasn't worked....
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Re: Does raising base rates really reduce inflation?
I too am not an economist and have little if any understanding of why interest rates need to go up to quell inflation that isn't home grown. If the average household has seen [say] £200 added to its monthly bill to cover utility costs then, in theory, as those costs reduce, interest rates will have to rise to keep that £200 out of inflationary pressures. But food prices have risen too, haven't they. Will they come down?
I think we are looking at inflation created by factors completely outside of our control. And I, perhaps quite naively, feel interest rate increases aren't the correct tool on this occasion.
I am not convinced that the BoE has actually got this correct, but as I’ve said my knowledge of economics would not fill the space taken up by an gnats gonad.
AiY(D)
I think we are looking at inflation created by factors completely outside of our control. And I, perhaps quite naively, feel interest rate increases aren't the correct tool on this occasion.
I am not convinced that the BoE has actually got this correct, but as I’ve said my knowledge of economics would not fill the space taken up by an gnats gonad.
AiY(D)
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Re: Does raising base rates really reduce inflation?
AsleepInYorkshire wrote:I too am not an economist and have little if any understanding of why interest rates need to go up to quell inflation that isn't home grown. If the average household has seen [say] £200 added to its monthly bill to cover utility costs then, in theory, as those costs reduce, interest rates will have to rise to keep that £200 out of inflationary pressures. But food prices have risen too, haven't they. Will they come down?
I think we are looking at inflation created by factors completely outside of our control. And I, perhaps quite naively, feel interest rate increases aren't the correct tool on this occasion.
I am not convinced that the BoE has actually got this correct, but as I’ve said my knowledge of economics would not fill the space taken up by an gnats gonad.
AiY(D)
This all rhymes with my own thoughts. Also, having had a base rate rise every month for a year now it seems to me that
A) they are having no effect, and
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.
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Re: Does raising base rates really reduce inflation?
Mike4 wrote:AsleepInYorkshire wrote:I too am not an economist and have little if any understanding of why interest rates need to go up to quell inflation that isn't home grown. If the average household has seen [say] £200 added to its monthly bill to cover utility costs then, in theory, as those costs reduce, interest rates will have to rise to keep that £200 out of inflationary pressures. But food prices have risen too, haven't they. Will they come down?
I think we are looking at inflation created by factors completely outside of our control. And I, perhaps quite naively, feel interest rate increases aren't the correct tool on this occasion.
I am not convinced that the BoE has actually got this correct, but as I’ve said my knowledge of economics would not fill the space taken up by an gnats gonad.
AiY(D)
This all rhymes with my own thoughts. Also, having had a base rate rise every month for a year now it seems to me that
A) they are having no effect, and
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.
It's not how I would do it personally - but if it's the only tool you have (practically or ideologically) it's all you've got; and it does remove a degree of discretionary spending headroom (otherwise folk wouldn't whinge about it)
But it's a handbrake on the front wheels of a rear wheel drive car - pulling that lever does stop it going, (would be better to take your foot off the accelerator though,) you create a lot of smoke and noise, and when it's finally raised there's a good chance stuff's going to get damaged as the whole shebang shoots off.... again!
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Re: Does raising base rates really reduce inflation?
Mike4 wrote:
This all rhymes with my own thoughts. Also, having had a base rate rise every month for a year now it seems to me that
A) they are having no effect, and
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.
What you have to remember is that the Bank of England has raised rates too little and too late. Compare them with the Fed.
Traditionally rates rose in 0.5% steps and fell in 0.25% steps. Don't forget that interest rates also affect exchange rates, so being behind the curve makes things worse from that aspect.
TJH
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Re: Does raising base rates really reduce inflation?
A doubling of energy and, off the back of that, food prices along with the highest tax burden in decades was bad enough.
..but Mr Baily being told to increase interest rates to a point where remortgage rates have tripled was a real kick in the spuds for many. A million fixed rate mortgages are due to expire this year.
And the 2 main drivers for this current inflation have subsided all on their own. Nothing to do with BOE interest rates. In fact you could argue that the BOE is itselfa major driver of inflation these days.
I'm no economist either, but how about keeping rates lower and forgetting the silly energy rebates for all (£400 for everybody, regardless of wealth) with a more targetted approach? How about the UK stopping its policy of actively selling QE bonds when every other country is just letting them run off?
As it stands, the mortgage market (buyers and btl's) is in turmoil. No doubt the mortgage free cash rich wealthy will scoff at the poor borrowing all that money at low rates, but wtf else were they supposed to do?
The problem is the lack of housing in this country.
..but Mr Baily being told to increase interest rates to a point where remortgage rates have tripled was a real kick in the spuds for many. A million fixed rate mortgages are due to expire this year.
And the 2 main drivers for this current inflation have subsided all on their own. Nothing to do with BOE interest rates. In fact you could argue that the BOE is itselfa major driver of inflation these days.
I'm no economist either, but how about keeping rates lower and forgetting the silly energy rebates for all (£400 for everybody, regardless of wealth) with a more targetted approach? How about the UK stopping its policy of actively selling QE bonds when every other country is just letting them run off?
As it stands, the mortgage market (buyers and btl's) is in turmoil. No doubt the mortgage free cash rich wealthy will scoff at the poor borrowing all that money at low rates, but wtf else were they supposed to do?
The problem is the lack of housing in this country.
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Re: Does raising base rates really reduce inflation?
Tedx wrote:The problem is the lack of housing in this country
Do you really have a lack of housing? In Scotland?
Where the population only reached 1974 levels in 2010?
Or has the golden goose of equity (as a proxy for growth; wealth through inflation) become a noose... or at least a miserable debt trap
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Re: Does raising base rates really reduce inflation?
AsleepInYorkshire wrote:I too am not an economist and have little if any understanding of why interest rates need to go up to quell inflation that isn't home grown. If the average household has seen [say] £200 added to its monthly bill to cover utility costs then, in theory, as those costs reduce, interest rates will have to rise to keep that £200 out of inflationary pressures. But food prices have risen too, haven't they. Will they come down?
I think we are looking at inflation created by factors completely outside of our control. And I, perhaps quite naively, feel interest rate increases aren't the correct tool on this occasion.
I am not convinced that the BoE has actually got this correct, but as I’ve said my knowledge of economics would not fill the space taken up by an gnats gonad.
AiY(D)
In theory putting up interest rates causes the pound to strengthen against foreign currencies, which in turn cuts the cost of imports thus reducing inflation.
Higher interest rates mean that people have a greater incentive to save more (and thus consume less). This reduces the amount of money that will be spent on goods and services. So demand falls and thus inflation falls. Demand is also reduced by making borrowing more expensive, which again reduces inflation.
However, the economy doesn't always work as theory dictates (especially on the macro-scale).
Always bear in mind that the dominant economic theory, neoclassical economics, is built upon several very shaky foundations (all of which have been mostly demolished by behavioural economics). Such as that people (and all other economic actors) are always perfectly rational, always choose to maximise economic utility and profits, always quickly and accurately process new information and that markets will always self-correct according to the laws of supply and demand.
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Re: Does raising base rates really reduce inflation?
servodude wrote: if it's the only tool you have (practically or ideologically) it's all you've got; and it does remove a degree of discretionary spending headroom (otherwise folk wouldn't whinge about it)
For months I have been saying that there is no cost of living crisis because all the restaurants and hotels are packed out. Inflation and higher interest rates had not crimped personal spending on hospitality and services.
But the last few weeks I have noticed that occupancy rates are down. The Marylebone Ivy restaurant used to require reservations every day, but now has a sign outside saying that it is accepting walk-in's - something that they never needed to do before.
London hotel rates are still high but have stopped going up - a decent 4-star place is 200 quid a night mostly - not low but not terrible. And they have rooms at short notice.
Airports are busy but then it is June.
So maybe higher rates are finally having some effect at the margin.
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Re: Does raising base rates really reduce inflation?
Lootman wrote:servodude wrote: if it's the only tool you have (practically or ideologically) it's all you've got; and it does remove a degree of discretionary spending headroom (otherwise folk wouldn't whinge about it)
For months I have been saying that there is no cost of living crisis because all the restaurants and hotels are packed out. Inflation and higher interest rates had not crimped personal spending on hospitality and services.
But the last few weeks I have noticed that occupancy rates are down. The Marylebone Ivy restaurant used to require reservations every day, but now has a sign outside saying that it is accepting walk-in's - something that they never needed to do before.
London hotel rates are still high but have stopped going up - a decent 4-star place is 200 quid a night mostly - not low but not terrible. And they have rooms at short notice.
Airports are busy but then it is June.
So maybe higher rates are finally having some effect at the margin.
That is all to the good in my book. I also like the feeling that interest rates are getting back to 'normal'. It cannot be healthy that we have had virtually free money for the last ten years.
Dod
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Re: Does raising base rates really reduce inflation?
Dod101 wrote:Lootman wrote:For months I have been saying that there is no cost of living crisis because all the restaurants and hotels are packed out. Inflation and higher interest rates had not crimped personal spending on hospitality and services.
But the last few weeks I have noticed that occupancy rates are down. The Marylebone Ivy restaurant used to require reservations every day, but now has a sign outside saying that it is accepting walk-in's - something that they never needed to do before.
London hotel rates are still high but have stopped going up - a decent 4-star place is 200 quid a night mostly - not low but not terrible. And they have rooms at short notice.
Airports are busy but then it is June.
So maybe higher rates are finally having some effect at the margin.
That is all to the good in my book. I also like the feeling that interest rates are getting back to 'normal'. It cannot be healthy that we have had virtually free money for the last ten years.
Dod
I agree. Maybe the guvvermint are grabbing this fig leaf of 'combating inflation' to lever up interest rates to somewhere sensible. Somewhere I intuitively feel they should already be.
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Re: Does raising base rates really reduce inflation?
tjh290633 wrote:Mike4 wrote:
This all rhymes with my own thoughts. Also, having had a base rate rise every month for a year now it seems to me that
A) they are having no effect, and
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.
What you have to remember is that the Bank of England has raised rates too little and too late. Compare them with the Fed.
Traditionally rates rose in 0.5% steps and fell in 0.25% steps. Don't forget that interest rates also affect exchange rates, so being behind the curve makes things worse from that aspect.
TJH
Go back to when gold (Sovereign Pound coins) were money. Being finite inflation broadly averaged 0%. Then in September 1931 Parliament Acted that deposited gold would be paid out as Pound notes, money was no longer gold, but paper money instead, that could be printed/spent and in so doing devalues all other notes in circulation. Predominate inflation was born. Previously the Crown/State had to pay real rates of return on deposited (borrowed) gold, but thereafter its cost to borrow dropped to zero (taxation/inflation), and where it had no real need to borrow when it could just print/spend instead. However by continuing to borrow (issue Gilts) then anyone holding (lending) at fixed rates, say 4%, would be hit if base rates/inflation rose to 5% (-1% real 'return' (loss)). Which deflates the debt. In effect those with money paying the state in order to lend their money to the state.
Higher rates also potentially promote investment. When interest rates were near 0% I was content to hold hard cash rather than lend it (deposit it in)to banks where once deposited it becomes the banks money, maybe returned, maybe not (but where protection regulations meant the first £85K was 'insured' to be returned). When there's inflation those with surplus capital are more inclined to invest it in order to try and offset otherwise loss of purchase power.
Raising rates also can have the effect of attracting money into the country. If the Brits are paying 4%, Germany are paying 2%, then all else being equal and investors may move money from Germany to Britain for the higher return that provides. However that goes hand-in-hand with perceived risk/value, will only be attractive if the governance and economy look safe/sound. In the UK's case under Sunak's Chancellorship and now PM Britain is a joke, money is out-flowing at a high/fast rate and the appeal for others to invest in the UK rather than elsewhere is low.
1952 and British inflation was over 9%, basic rate taxation was increased to 47.5%, savers had to earn over 17% gross in order for those savings to have maintained purchase power. Many obviously wouldn't have and as such have lost some of their wealth. 1975 and inflation rose to 25%, taxation increased to 35%, savers would have had to earn a 38.5% gross return in order to offset inflation in net terms. It only takes a couple/few years of such policy to wipe out a lot of individuals wealth.
Inward investors like such situations, where the citizens in real terms are in effect prepared to continue working/saving, for much less. LT/KK intent was to stem the outflow of money, keep the 1% that pay a third of the tax take, if not see that number double. Potential inward investment/money didn't like that so ejected them in favour of Sunak's managed/accelerated UK decline alternative.
Sunak has pledged to halve inflation, down to still being near 300% of target inflation, promised at a time when inflation was believed to have peaked (in double digit figures). He's also promised to grow the economy, which is easily achieved via opening up large-scale migration, further aided by 'cheap' workers (bordering on slave levels of cost/pay). He promised to reduce the national debt, i.e. not continue to repeatedly spend three digit billions amounts on wasteful things such as Fulough. He also promised to cut NHS waiting lists, and then came out with the stupid idea that GP's should be taken straight out of school-leavers instead of going through their normal many years of training. He also promised to pass legislation against small boats entering the UK, which as a sovereign country that should be defending its borders anyway is just indicative of a intent to throw money at border controls.
A problem is that come the next GE those that vote for the MP they'd most like big-money to control for five years, only have the option to vote for a back-stabbing closet socialist, or a actual socialist. Good news for big money, a sustained bad outlook for the population in general.
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Re: Does raising base rates really reduce inflation?
Sometimes I wonder if the government knows what it's doing.
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Re: Does raising base rates really reduce inflation?
CliffEdge wrote:Sometimes I wonder if the government knows what it's doing.
I've had this impression since I was about 13.
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Re: Does raising base rates really reduce inflation?
Mike4 wrote:Dod101 wrote:
That is all to the good in my book. I also like the feeling that interest rates are getting back to 'normal'. It cannot be healthy that we have had virtually free money for the last ten years.
Dod
I agree. Maybe the guvvermint are grabbing this fig leaf of 'combating inflation' to lever up interest rates to somewhere sensible. Somewhere I intuitively feel they should already be.
The guvvermint (sic) don't decide interest rates in the UK, quire rightly.
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Re: Does raising base rates really reduce inflation?
dealtn wrote:Mike4 wrote:
I agree. Maybe the guvvermint are grabbing this fig leaf of 'combating inflation' to lever up interest rates to somewhere sensible. Somewhere I intuitively feel they should already be.
The guvvermint (sic) don't decide interest rates in the UK, quire rightly.
I disagree. They do by proxy.
Yes on a day to day basis the BoE sets them, but I am under the impression this only happens with the permission and approval of the government. (See, I can spell it!)
Should the guvvermint (channelling Arthur Scargill and his pronunciation of the word) decide at any time they don't like the way the BoE is managing base rates, that function can be taken back into being a ministerial rôle. Is this not the case?
Or having delegated the task to the BoE, do you hold there no way for it to be taken back from them?
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Re: Does raising base rates really reduce inflation?
tjh290633 wrote:What you have to remember is that the Bank of England has raised rates too little and too late. Compare them with the Fed.
Like one has gone from 0.25% to 5.25%, and the other from 0.25% to 4.5%, with the BoE going first (coupled with reversing QE). Not sure how you are attributing the too little and too late moniker to the UK when it acted first and is using more than one tool to tighten monetary policy.
https://tradingeconomics.com/united-states/interest-rate
https://tradingeconomics.com/united-kingdom/interest-rate
The £ being stronger against the $ over that tightening cycle.
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Re: Does raising base rates really reduce inflation?
Mike4 wrote:dealtn wrote:
The guvvermint (sic) don't decide interest rates in the UK, quire rightly.
I disagree. They do by proxy.
Yes on a day to day basis the BoE sets them, but I am under the impression this only happens with the permission and approval of the government. (See, I can spell it!)
Should the guvvermint (channelling Arthur Scargill and his pronunciation of the word) decide at any time they don't like the way the BoE is managing base rates, that function can be taken back into being a ministerial rôle. Is this not the case?
Or having delegated the task to the BoE, do you hold there no way for it to be taken back from them?
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?
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Re: Does raising base rates really reduce inflation?
So much of the wealth of the UK population is tied up in ever rising house prices and so it will probably be necessary for the BOE to strangle this ever rising house price wealth in order to get a real grip on inflation.
As long as people see their “UK house wealth” increase by more than their “UK annual salary” every year, then they will keep feeling “richer” every year and happy to pay 10% more every year on their groceries and other expenses.
If the only way for the BOE to strangle this illusory UK wealth is through higher interest rates then it will be a price worth paying.
The UK needs to greatly increase its skills and productivity to increase its wealth, and to stop relying on increasing its wealth through illusory house price wealth.
As long as people see their “UK house wealth” increase by more than their “UK annual salary” every year, then they will keep feeling “richer” every year and happy to pay 10% more every year on their groceries and other expenses.
If the only way for the BOE to strangle this illusory UK wealth is through higher interest rates then it will be a price worth paying.
The UK needs to greatly increase its skills and productivity to increase its wealth, and to stop relying on increasing its wealth through illusory house price wealth.
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Re: Does raising base rates really reduce inflation?
dealtn wrote:Mike4 wrote:
I disagree. They do by proxy.
Yes on a day to day basis the BoE sets them, but I am under the impression this only happens with the permission and approval of the government. (See, I can spell it!)
Should the guvvermint (channelling Arthur Scargill and his pronunciation of the word) decide at any time they don't like the way the BoE is managing base rates, that function can be taken back into being a ministerial rôle. Is this not the case?
Or having delegated the task to the BoE, do you hold there no way for it to be taken back from them?
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?
Can the government take back control of interest rates, or not?
If yes, then the BoE autonomy is an illusion.
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