Economics for dummies

[Clueless2023]

Please can someone explain to me in simple terms why the Bank of England keeps raising interest rates. I understand that it's to curb inflation, but I'm really not sure what that means, what inflation is and why it's bad?

The interest rises mean people pay more on their mortgages so have less to spend on things like holidays, new clothes, eating out, socialising, etc. But surely this means that these industries then suffer, some go under, people lose their jobs, more people reliant on benefits? I just don't get it?

Also, I've read in the news today that the government are being asked to step in to help people who are struggling with their mortgages... but why would they do that when they are the ones who made the decision to raise interest rates? Or do the government not control the Bank of England?

Isn't it...

1. interest rates increase

2. borrowing becomes more expensive, meaning people borrow less

3. less borrowing = less spending

4. less spending forces sellers to lower prices to be more competitive

5. lower prices = lower inflation?

Increasing interest rates does 2 things that (should) help with inflation:

1. higher interest rates encourage savers to save instead of spend
2. it lowers the amount of money other people have, as they are paying more on mortgages … thus reducing spending.

Both of these lower the amounts being spent, which should reduce demand, and reduce inflation

However, our economy (post Brexit) is really quite damaged, and the import / export costs that are really hammering us. There is no getting away from higher prices, it was always going to be a consequence of removing ourselves from our EU trade deals (not just with other European countries but with the rest of the world). We are always going to be reliant on imports, so it’s unlikely that pure Demand Side Economics is going to work to fix our current problems.

A few links from the Bank here that might help:

https://www.bankofengland.co.uk/explainers/why-are-interest-rates-in-the-uk-going-up

https://www.bankofengland.co.uk/explainers/how-do-higher-interest-rates-help-to-lower-inflation

https://www.bankofengland.co.uk/explainers/inflation-and-interest-rates

The prime minister has been very clear that he will not be taking any preventive measures for the housing market. We are on our own & it’s going to be tough for the next 1-2 years at least.

I would advise anyone considering offerIng on a property now to look at their offer realistically and not be swayed by estate agents blurb on “what it’s worth”!

The economy is not in a strong position at the moment, which the national debt to GDP figures highlight.

What I don't understand is why interest rate rises are the best option?

If we want to take money out the economy why wouldn't you increase i.e. taxes and reduce the government's deficit, then it would be able to be targeted rather than blanket and it would avoid money just being spent on giving banks interest.

I understand that the BOE are a) independent and b) don't have many tools in their box, but it seems mad to me that this is the best option and I just don't know why they wouldn't take coordinated action with the government?

Or if not the suggestion above some other mechanism?

My issue with the interest rate approach is that the inflation isn't being driven by spending - it is global economics cost of fuel and grain etc so it really is a blunt tool and could drive recession in imo

Inflation can be driven by a hot economy where there is lots of money and people spend (and borrow) lots. In this case raising interest rates works by slowing spending because money is more expensive to borrow. However, what we are seeing is supply side inflation where goods and power costs are increasing due to supply chain issues. Raising interest rates in this case does absolutely nothing to stop inflation, and will likely cause a recession. But because it is the only tool in the economic kit that this fucking dreadful brexitty govt are willing to use (because anything else admits that brexit was an utter disaster for the UK) this is what they will keep hammering us with. Sunak is a terrible, incompetent and completely out of touch PM, possibly the worst person to be in charge right now. The future is looking pretty bleak imo.

Rising interest rates cause foreign investment which means £ have to be bought to invest in UK. Raises demand for sterling which increases its value against other currencies. Price of imports drop.

@Augend23 Largely because the Government control tax rates, and if they raise them in the run up to a general election, they reduce their chances of being elected again

@Augend23 just to clarify- this particular bunch of Cock Wombles not being re-elected would be a huge economic, social and personal relief!

Ok I'll try to make this as simple as possible but it is confusing.

1st the massive jump in inflation is predominantly down to the quantative easing (printing more money) during covid. Each pound is worth a certain amount of gold and when you print more money without any more gold the Each pound is worth less internationally. It was also driven by market forces such as lack of natural gas and grain (caused by the war in Ukraine). The shortages pushed the prices up which has a knock on effect on prices of goods, which then drives people to demand pay rises which the cost of is also added to the manufacturing costs so pushes prices up further. This increase in prices is what's known as inflation and the amount that things increase in cost by is the inflation rate.

2nd to curb inflation so we don't end up with hyper inflation like we had in the 70s there are a couple of things that the government can do. They can refuse pay rises for all civil servents (including drs, nurses and teachers) which would need to be paid for by raising taxes for everyone and every business and/or borrow more money, both of which push inflation higher for everyone. Or they can put up interest rates which means people have less disposable income so they buy less so there's more supply than demand which pushes prices down and lowers inflation. Our government has chosen to do all of the above to bring down inflation which in the long term is good for the many but in the short-term is really bad for the few and not great for everyone else.

Basically it's a choice of the lesser of 2 evils either we let inflation run amok and everyone loses with even the upper middle class unable to pay there mortgages and buy food and the people at the bottom starving to death because they cannot afford food and charity's can't help and most businesses going bankrupt. Or some people who over extended themselves on mortgages and other loans lose their homes, a few businesses go bankrupt and everyone is skint for a couple of years. I'm not going to lie and say that either choice is great but sometimes hard choices need to be made and the cold hard fact is some people will have to lose everything so that everyone doesn't lose everything.
Having lived through housing market crashes and recession before I can honestly say it's not a nice thing to see but it will have winners aswell as losers because the housing market has gone crazy and this will make house prices more affordable for 1st time buyers and savers will make more money, but generally its pretty shit for everyone

The other thing to consider is the employment issue - businesses are short of staff (thanks to Brexit and the post Covid Great Resignation) and the main mechanism they have to attract staff is to increase pay rates - but in many sectors businesses are restricted on what they can charge consumers because of the cost of living crisis so profit margins are pretty tight. if consumers do reduce spending further because of interest rate rises, and businesses are paying more interest on their liabilities, businesses go under, the UK becomes less productive.

@Hoardasurass that's a good explanation thank you
its a pretty big shitshow though isn’t it ? A total blunt instrument that doesn’t seem to be working as fast as thought. Andrew Bailey seems out of his depth as does the rest of them sure levelling up is good but the clue is levelling up not down which is what it looks like now

The key issue is that the Bank of England (a) mucked up its inflation forecasts and (b) was far too late to take decisive action and raise rates.

I was chatting to a bond fund manager recently and he was highly critical of the BofE. Whereas the Fed got ahead of the curve and they've already got inflation back to 4% in the US. He said bond markets are pricing in four more interest rate increases at the moment (up to 5.5-6%j.

While there are many factors behind inflation, raising interest rates will make a difference. There's been a significant delay due to the high number of fixed rate mortgages (95% of people mortgaging since 2019 chose fixed rates).

There's over a million fixed rate mortgages coming to an end this year, most at under 2%. That will start to impact spending if people are remortgaging at 6%.

We can't continue with inflation at 8% so, unfortunately, it's a necessary pain. Interest rates are still lower than my first mortgage (granted that house prices are very different). The near zero interest rates were an exception, if you look back at the base rate history.

Also if interest rates keep going up people just won’t sell unless they need to so housing becomes less prolific keeping prices high plus mortgages won’t be available it’s a total mess a perfect storm Brexit Covid QE war in Ukraine is there any positives anywhere

Unfortunately @Parsley1234 many people won't have the choice not to sell they will have a choice between selling with negative equity (house worth less than they paid) or default on their mortgage and the house will be reposed which will further drive down the value of property trapping more people into negative equity. This in turn puts more pressure on the rental market.
But the people who are stuck living at home with parents who have been saving for a 1st home will see there savings grow faster due to higher interest rates and houses will be cheaper so they will be able to buy and pay a mortgage which will stabilise the housing market though it normally takes 3-5 years to happen

It’s going to be a total fuckup there are no rentals if houses do get repossessed there’s no where for people to rent what a mess such incompetence

Everything is the fault of Brexit. Absolutely everything.

Meanwhile, the German Ifo survey (well respected economic research institute) issued a forecast yesterday saying the GERMAN economy is expected to contract more than previously expected in 2023 due to sticky inflation and high interest rates.

But, you know, Brexit.

If you want a more feasible explanation you could look to things like: supply side shocks with energy prices and food production (war in Ukraine), rising living standards in eastern europe and China which means that cheap labour is less abundant (even within the EU) and the great deflationary effect of cheap Chinese exports is weaker than in recent decades, and overhang from the effects of Covid.

It's complicated. But comparable economies in the EU aren't faring much better despite the doom-mongers here who love to talk us down.

I received an email from my energy company yesterday saying my rates are coming down from July. I think there'll be some relief on the price front fairly soon.

There isn’t much point in giving people money to offset the mortgage rises

@grass321 your post is interesting, why do you think the BoE got it wrong? Ie what was their thinking / flaw

if you know

I agree it’s supply side inflation. Out of interest what would you want to see

Do you mean join the SM / CU it was it something else?

That's true @Parsley1234 but a smart government would take this opportunity to fix the housing market once and for all by undoing the harm done by Margaret Thatchers right to buy lie.
When people were sold the lie of houses being an investment instead of somewhere to live it created the unstable rental and housing market. Before this it was the norm for people to rent with very few people owning property as such there was more than enough rental properties and housing prices stayed relatively stable. Then we sold off all the council houses at the same time as telling people that they must own a home to be someone creating the aspiration of home ownership, which gave us the double whammy of lack of supply in the rental market increasing costs for renters which fuels the desire to own a home which artificially inflates the housing market creating the boom and bust situation. Building more social housing and going back to cheap rents and secure tenancies would deal with supply and demand issues and put unscrupulous landlords out of business and free up more property's for home owners at a reasonable price or for councils/social housing groups to buy and then rent out on a npo basis.
It would mean increasing borrowing and tax for a short time but it would create jobs and drive up productivity which would in turn increase tax revenues which would allow us to pay off the debt quicker and then reduce tax and give people a better quality of life.

The reason no government (both labour and tory) has done this is because it would crash the housing market but we are at a point now that the market is going to crash no matter what and there is growing demand for social housing amongst the general public and it would help fix inflation. The only question is will any government be brave enough to do it will hurt landlords and those who own outright (ie no mortgage)

@Hoardasurass yes I can see that however what’s happening now is that the government are moving over to a private equity takeover of rentals which will be the like if John Lewis and Lloyds the BTL landlords are leaving in droves and it’s a total mess

your post is interesting, why do you think the BoE got it wrong? Ie what was their thinking / flaw

I think the major issue is that their inflation forecasts were totally wrong. The BoE has admitted this, and they were estimated to have mis-forecast it by 6 percentage points between December 2021 and March 2022.

If your inflation forecasts drive interest rate decisions, that's a huge error. There's a good graph on Reuters which shows the difference (we're talking 2% v 11% at one point).

The BoE should have raised rates more quickly at the beginning. We've still got inflation at 9%, the US is back to 4%. We've got energy costs falling but food inflation is still around 19%.

I don't believe it's all due to Brexit. If you want to point the fingers, I'd start with the war in Ukraine, then the pandemic which disrupted global supply chains plus the QE we saw as part of that. It created a perfect storm for inflation,

Or do the government not control the Bank of England?

The BoE is independent, has been since Gordon Brown made it so.

The Bank of England under Carney was an intelligent steady pair of hands Bailey looks what he is out of his depth imbecile