Losing interest

Prepare yourselves: this is going to be about interest rates.

Wait, don’t go! Interest rates are really jolly important to wealth, wellbeing and societal justice. In a time of austerity, it’s easy for people to take sides over fiscal policy (that is, how much the government taxes and spends). But arguably more important is monetary policy (that is, the control of the money supply).

The Bank of England (BoE) controls monetary policy in the UK, independent from government. Today the Monetary Policy Committee (MPC) of the BoE again announced its vote on what to do about interest rates and quantative easing. For the last 32 months (32 months!), interest rates have been kept at a multi-century low of 0.5%. Given that in the 317 years of the BoE’s history they had never previously been below 2%, that’s a pretty amazing stat and indicative of the hole the Bank thinks we’re currently in. But the MPC now thinks that hole may be getting bigger and has therefore decided to once again crank up the electronic printing press to restart quantative easing, to the tune of GBP75 billion.

See that? That's a graphical representation of how shafted the BoE thinks the UK's economy is.

So, why is QE once again being pursued? Essentially, QE involves the purchasing of financial assets, usually government bonds, by the central bank to inject a certain amount of new money into the system. This has the effect of lowering longer-term interest rates, while also providing liquidity to the system. In 2008, this was necessary because no one was lending to anyone, so the BoE essentially adopted its role as lender of last resort.

With the eurozone crisis worsening by the day, banks in the EU and the US have again found it difficult to raise capital. A burst of QE now could flush a bit of money through the system, oiling the wheels of capital and getting funds flowing again.

Oooh, a colourful chart. This could mean the market views the probability of Italian banks' default as rising. Or it could be an Italian five-year old's attempt to draw a pretty landscape with crayons. We're just not sure.

The thing is, the ultra-low interest rates we’re currently holding and QE don’t necessarily benefit the people one would like them to. The cash created by QE has in the round obstinately refused to work its way beyond the banks into the wider economy and is instead being used to recapitalise the banks’ and other companies’ buffers. In addition, the people to gain most from very low interest rates are people who are over-indebted. That is, the people who caused the financial crisis in the first place. Thus, homeowners who borrowed too much on their mortgage and banks who lent too much on these and other assets. Not only does this create a case of moral hazard, where a risky venture is essentially made risk-free (and therefore more attractive and likely to be pursued repeatedly despite its damaging effects), but it also is patently unjust.

Unjust, you say! Strong words. But let’s take the most obvious and pernicious example of the effects of this expansionary monetary policy: house prices. Low interest rates encourage and allow people to borrow more money, thereby ensuring house prices will be higher. Keeping house prices high means that banks’ balance sheets aren’t bloodstained and awash with red ink. This essentially keeps the banks solvent. All well and good, but the housing situation is perhaps the most unjust aspect of our society currently, locking out younger and poorer sections of society from the benefit (if that’s what it is) of owning their own house and condemning them to short-term, unstable and often less salubrious rental properties.

In Hackney, the average house price is £383,634 (source: Land Registry). That’s nearly four hundred grand! For an ‘average’ house (that is, most probably a a two- or three-bed flat). The average (median) salary in Hackney in 2009 was under £27,000, or just over £30,000 for full-time employees (source: Hackney Council). Let’s be generous and say the average salary is now £31,000. This means that the house price to salary ratio is more than 12. That’s an astoundingly high number and means it is totally impossible for anyone under the average salary to even contemplate a mortgage, even on two incomes, to buy a house. That’s even before you’ve counted the deposit required (let’s say 20%, which would be more than £75,000 – a couple on the average salary saving 10% of their income would take 16 years to reach that figure). The only people able to buy these properties are therefore the rich (who are few in number) or developers and landlords, who given the high competition for rental properties when no one can afford to buy, can charge higher rents, which makes it more difficult for people to save a deposit to buy a house, which means they have to rent for longer, which means……well, you get the picture. Vicious circle, anyone?

Oooh look. A lovely graph of the five-fold increase in average salaries in Hackney over the past 16 years. Oh no, hang on.....

Should we be raising interest rates for the sake of society? Probably not, because the economic clustermuck we find ourselves in may be too great to handle a rate rise. But it also suggests that the MPC, which held rates down too low for too long in the 2000s, encouraging the house price boom and subsequent credit crunch, may have done the same in the late 2000s. This leaves them with little room for manoeuvre when another crisis hits, entrenches the injustice of house prices (which, by the way, are also economically non-productive; the more we pay for houses and rent, the less we pay for good, services and investment) and saves exactly those people who caused the problem in the first place: the banks and the indebted. While also arguably stoking inflation and hence impoverishing the population at large.

No wonder Occupy Wall Street is gathering pace. But perhaps we should all be venting our anger outside the Old Lady of Threadneedle Street as well as Canary Wharf.

The Bank of England's architect realised his mistake when he took off his panoramic glasses.

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