The Bank of England Act 1998 says it should make price stability its priority. Its current actions suggest other objectives...
THE BANK OF ENGLAND'S base rate has been languishing at 0.5% for so long that nobody is asking the most basic question: "Why?, says Simon Rose of Save Our Savers.
The Monetary Policy Committee decision to cut it to 0.5% in March 2009 was because "the February Inflation Report had implied a substantial risk of undershooting the 2% CPI inflation target in the medium term and a further easing in monetary policy was likely to be needed." Fear of deflation inspired the cut and the accompanying £75 billion of Quantitative Easing.
Now though, 31 months later, the situation is rather different. CPI inflation is 4.4%, yet bank rate is still 0.5%. The MPC's inaction over base rates is odd, given that the MPC's role is explicitly to set an interest rate that it judges will enable the Government's inflation target of 2% to be met. Mervyn King's letters of apology to the Chancellor repeatedly claim that inflation will fall in due course, even though the Bank of England, which has a record of consistently underestimating inflation, is forecasting it to go to 5%.
Some commentators believe the MPC is giving prominence to other economic considerations. The Wall Street Journal recently reported that the Bank of England "is no longer targeting inflation. There's no other way to interpret Governor Mervyn King's open letter on why inflation remains above the bank's 2% target...By his own admission, Mr. King has said a country's inflation rate is entirely down to the central bank's choice. The Bank of England could have met its inflation remit, but only at the expense of driving down the growth rate."
Could the members of the MPC be more concerned about the fragility of the UK economy than inflation? If so, then they could be acting illegally. Section 11 of the Bank of England Act says that the MPC must maintain price stability (defined as CPI inflation of 2%) as a priority over any other element of economic policy, including growth and employment.
So why is the Chancellor content with Mervyn King's excuses about failing to bring inflation under control? Perhaps he hopes that low interest rates will boost the economy. Yet unsecured borrowing costs for consumers and small and medium-sized businesses are the same or higher than before the crash, when base rate was 5%.
A £5,000 personal loan, for instance, was charged 11.47% in September 2008 but 15.21% in July 2011. That's for those who can get loans. According to the Federation of Small Businesses, a third of companies approaching banks for loans have been turned down.
Mortgage costs have fallen, but mortgages are not income-generating investments. Encouraging people to buy houses at the expense of investment in the productive economy is simply exacerbating the problems that got us into this mess in the first place.
Consumer confidence, so we are told, is essential if we are to see growth restored to the economy. Yet the MPC's low interest rate policy is actually depressing confidence. The pound has lost 25% in value, with the increased cost of imported essentials, including fuel, adding to inflationary pressure.
Inflation inhibits growth and depresses demand. While some over-extended borrowers might sleep more soundly, with the economy flatlining and wages not keeping pace with inflation, everybody else feel poorer and reins in spending.
The current climate certainly does nothing for the confidence of savers. With bank rate at 0.5% and inflation pushing towards 5%, UK savers are losing over £50 billion a year. Let us not forget – though the MPC appears to – that savers vastly outnumber borrowers.
But then, as the Wall Street Journal says, "As academic economists with a Keynesian background, much of the MPC is contemptuous of savers. Savers, or rentiers as Mr. Keynes called them, were a drag on an economy's potential and deserved to have their money confiscated – his euthanasia of the rentier."
The MPC's remit is to keep inflation under control and it is doing a dreadful job of it. If the UK's central bank is to maintain its credibility, the Chancellor should either tell the MPC to do its job properly or change the inflation target.
We cannot have a balanced, growing economy without savers. They provide much-needed capital which is then lent on and invested. Current policies risk squeezing savers to the brink of extinction. After 31 months, it is abundantly clear that having a record low base rate is not working.
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