Don’t Cut Rates Again – It Will Make Things Worse

by Dr. Ros Altmann

(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)

---

The Bank of England has cut rates again. This is another policy mistake. More panic cuts are not the answer to our economic crisis. Policymakers are desperately trying to boost the flagging economy, encouraging more spending, lending and borrowing, but lower rates are a very crude weapon. They punish those who have got money to spend, while benefiting the very groups (the banks in particular) whose actions caused the mess in the first place.

5 reasons why rate cuts are hurting the economy:

Damage to confidence undermines the economy Have not given previous cuts time to work Damage pensioners – more poverty, like cutting state pension May not boost lending anyway Huge inflation risk

1. Damaging confidence: When they see policymakers panicking, people reduce spending and retrench.
3. Not given time for past cuts to work yet: Monetary policy operates with a lag. Continued economic weakness does not necessarily demand more rate cuts. If a patient fails to recover immediately, the sensible doctor either gives the medicine time to work, or changes the treatment, rather than constantly doubling the dose. An overdose could prove fatal. The same may apply to rate cuts, however frustrating that might be for policymakers desperately wanting to ‘do something’!
5. Damage to savers and pensioners: Millions of pensioners, who rely heavily on savings interest, have seen their incomes slashed and are reducing their spending. Rate cuts are like cutting the state pension. Disgracefully, pension credit means-tests still assume pensioners are earning 10% (yes, 10%) interest on their savings. This pushes more into poverty, damaging consumption. If half of Britain’s 12 million pensioners have £10,000 of savings, recent rate cuts imply £10 a week less income, costing over £3billion a year.
7. May not work anyway! Lower rates will not necessarily boost lending, as lenders increase margins, and raise charges on loans. The problem is the availability of credit, not the price.
9. Huge inflation risk: Consensus concerns about deflation are misguided – this is a temporary statistical phenomenon after the sharp price rises in 2008. In fact, dramatic rate cuts, printing money to offset bad loans and pumping billions into the failed banking system is setting up inflation for the future. This will again hurt innocent savers as the value of their savings will be slashed by inflation.

So, if lower rates won’t help, what could be done?

Government needs to get involved more directly. A Government sponsored lending body, rather than relying on banks, would get loans to viable businesses more quickly. Cutting direct taxes by reintroducing the 10p tax rate to give people more money in their pockets, changing the ludicrous pension credit assumption of pensioners earning 10% on their savings, and direct lending to viable businesses would offer far more effective stimulus than just hoping lower rates will eventually kick-start lending by bankrupt banks. Lower sterling will also provide some stimulus soon. Government should take charge and the Bank of England should resist aggravating future inflation via more damaging rate cuts.