To not understand how raising the interest rate works?

[Charlavail]

Surely then people will just have even less money to spend and the economy won't improve?
Sorry for my naivety.

I’m old enough to remember previous cycles of interest rate rises, which happened because the economy was ‘overheating’ and demand for goods & services was running ahead of supply, which caused inflation.
This time is different, though. It’s the price of the essentials of life : food, energy & fuel which are going up fastest as a result of global supply shocks. I’m not sure how taking money out of the pockets of ordinary people by making their mortgage payments higher is going to change that.
I’m not suggesting that there are any easy answers to this mess, but I’m not convinced that this is the right response either.

I kind of trust BoE not to be political in that way but he was so scathing, said they were subscribing to group think and that there’ll be a screeching u turn when the data starts to come in. Depressing if true

We never really recovered from 08 & then Brexit & covid. We've had low growth & hardly any investment. The economy is basically based on house prices. I can't see the solution as we have an ageing population so things will be more & more expensive.

Does anyone have the interview?

This

It was Times Radio, former BoE person. Presenters sounded taken aback at strength of feeling (a bit like when Hands guy did an interview the other day). I’ll have a look around to see if any article but not sure if they have a catch up. Probably around 8ish am

Higher interest rates mean people borrow less and spend less. So the economy slows down and companies can’t put their prices up so quickly.

Stupid question but is there an economic model that actually works? Vs. this one with its fiddle with this to influence that, that falls, so fiddle with something else, boom-bust cycle that just seems to fuck people over.

I thought we spent too much during Covid and the crash in 08 was sub prime related (so loading system with extra risk) but I think if we didn’t have this war we’d be mostly ok.

The actions both sides are taking are to squeeze and cause hardship to each other and it’s working, especially in Europe - as US has better energy supply,

They are raising rates as much because the rest of the world on which we depend will charge us a lot more for stuff if they don't

Which would in turn mean higher prices and higher taxes

Aka we are stuffed either way

I understand the theory (in basic terms) but I’d be interested to know what the plan is for businesses which rely on discretionary spending. Almost every household is losing hundreds per month which might otherwise have been spent in hospitality / retail etc. And people who work in those businesses are likely going to lose their jobs as things get worse. I’d assume recession and higher unemployment would generally bring inflation back down, at which point interest rates should stabilise, but not sure if that’s going to be true this time round.

My understanding is that BoE doesnt want the pound to tank in addition to a recession. In theory, an overheated economy can take higher interest rates but this is not it. In this case, they are trying to follow the fed so the pound doesn't tank against the dollar. But domestically it will be really really tough. Having said that my brother is currently trying to buy a place in London and keeps being outbid by cash buyers so not everyone is feeling the pinch

Marsha/Worrie - Professor Blanchflower? He was an external member of BoE Monetary Policy Committee in the Noughties.

"Raising rates today, as well as spending cuts and tax rises, is "a horrible mistake", @D_Blanchflower told me. We're already in recession and so inflation has peaked, he argues. He predicts both the Bank of England and the Treasury will u-turn come the new year. Let's see"

twitter.com/tnewtondunn/status/1588173282536493056?s=46&t=0lTGdBe49rn3S5rw35AUbg

The problem is that inflation causes absolute misery for the poorest. I was travelling in the 1980s in a country where we changed a little money twice a day because inflation during the day was so high that our morning's money had lost an appreciable amount of its purchasing power by the evening.

Rich people (and those with access to a stable currency) don't suffer so much, but the 'nasty Tories' (actually the BoE) are trying to ensure that the poorest retain as much spending power as possible. Increasing pay or benefits just drives inflation faster. (See 1930s Germany)

OK.

So why has the pound weakened against the dollar in reaction to rates being raised, if that was the right thing to do for exchange rates? That doesn't help with inflation as it makes imported goods more expensive. Plus it might increase demand from foreign tourists as it will make travel to the UK cheaper for them.

Thanks yes that’s him

There is an old (not funny) joke about economists:

Why do economists exist?

To make weather forecasters look good.

There are a lot of fallacies around rate setting. The first is that the BOE is somehow "independent" and can set its rate independent of the rest of the world. It can, but the consequences of this are that it would trash the currency, as all the money would move to countries that offer a higher return.

Currently the major western banks are all increasing rates (US, Canada, Europe), so we have to increase rates too. The primary driver at the moment is the US, but Europe are not so far behind. We have to keep our rates competitive with the US otherwise the currency is toast.

So the government has a choice, either trash the currency or plunge the country into a recession. The second of those is a better choice than the first (but the first might lead to the second and vice versa).

The real issues will start to come if the US cannot get its inflation rate under control. There are a lot of people who believe it did not start raising rates early enough, so now it will have to raise rates higher in order to crush inflation. In that scenario, we may be in a situation where the US continues to raise rates, and even though we have been plunged into a recession we will need to continue to raise rates along with them and Europe to stop a currency collapse. This could result in a sustained and prolonged recession (depression).

Most of this is fall out from the money printing we did after the GFC of 2007-2008. We used QE to mitigate the recession, which was probably the right thing to do. But unfortunately rather than using it to buy time to restructure the economy through the 2010s, we basically returned to our pre-2007 behaviour, building an economy again too dependent on credit and ever inflating assets such as house prices. This was encouraged by keeping interest rates far too low, and boosting the housing market with unnecessary policies like help to buy.

During the 2010's we had a great opportunity to let asset prices/house prices fall gradually and let the market reset and come to a better equilibrium point, but instead government policy and low interest rates pushed them ever higher.

Now we are in a position where we have no choice. We can't borrow or print money to bail out those who have taken on too much credit - the markets won't let us. We have to continue to raise rates to protect the currency, if we do it is likely to put us in recession, if we don't it will trash the currency. So it is a case of a hard object meeting a brick wall. There are no easy choices moving forwards.

Great post Gas, makes sense. Depressing though but can see the rationale.

I understand how it works, what I don’t understand is how it’s supposed to work when are are crippled by mortgages, increased food bills and increased fuel costs. It’s not like we all need to give up having our nails done (which if everyone did, would close those businesses) or spending all of our money in Starbucks. We are spending to keep a roof over our heads, food in our bellies and not freezing to death!

I don wonder whether the hint that markets are over-estimating BoE's potential interest rate hike in the future is also wrong. So long as the Fed keeps rising - wont BoE have to keep apace?

They are not looking at individual cases

The bottom 10 or 20% of the population is in dire needs but not everyone is really

Yes some businesses will fail - that they do understand
Yes people will lose their homes

They can't / won't protect everyone

That is really informative, gaspanic, thanks.

We have a population of 67 million. You’re talking 6-12 million people here.

The aim is to stabilize Sterling, improve exchange rates and keep the cost of borrowing down. Otherwise, the cost of imports will increase, making almost everything a whole lot more expensive. Even more expensive than 10% inflation will.