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This is a space for me to comment on Economics both in terms of the specific bits if economics, how the discipline works and the academic politics. I might also be tempted into talking about the economy!

Back to Financial Repression.

Monetary PolicyPosted by Huw Dixon Sat, January 14, 2017 16:47:40

The Monetary policy committee (MPC) in the UK seems set to repeat the imposition of financial repression we saw in the period 2010-12. That is the aggresive reduction in the real interest rate by failing to keep the nominal rate up with inflation. Inflation looks set to rise to 3-4% in 2017-18, with nominal interrest rates left at 0.25 or 0.5% (as seems the plan), that means a negative real interest rate of -2.5 to -3.5%. Now in 2010 that may have been an excusable policy: we were in the extraordinary times of the immediate aftermath of the finacial crisis. However, there is no justifucation in the current state of the economy for reducing real rates so rapidly to such a low negative rate. The role of the MPC is to target inflation, which requires nominal interest rates to rise at least as much as infation is expected to increase (i.e. the Taylor principle, that real rates rise when inflation rises above target).

Real interest rates should almost never be negative. Prior to the 2008 crisis, the only time real interest rates had been negative was back in the 1970s during the "Great Inflation". Back then there was an excuse: people did not really understand inflation and how to cope with it. The failure to keep real interest rates positive is widely seen as simply bad policy. Since then, real interest rates have nearly always been positive, with nominal rates being around 1-2% higher than inflation.

In the last year, we finally had a return to a positive real rate: the policy rate was 0.5 and inflation was around zero. However, the MPC and Governor Mark Carney have openly stated that they intend to keep the policy interest rate at its current level whilst inflation will be well above target. This will be seen as an historic failure of judgement by the MPC. Financial repression on this scale will lead to a massive redistribution of income, with the Bank of England in effect becoming a major instrument of fiscal policy, taking from savers and pensioners and giving to borrowers. This sort of redistribution is not what the MPC is about. Its role is targeting inflation, something which it seems to have forgotten.

What about Brexit? Well, Andy Haldane (the chief economist at the Bank of England) has admitted that the Bank's forecasts overstated the effect of the Brexit vote on the real economy. The real effects of brexit have yet to come into play (Brexit has not happened yet). However, the implication is that the post Brexit cut in interest rates needs t be reversed: I have yet to see the MPC indicating that this is what it intends to do.

In the US, interest rates are rising: this is something that the UK would be well advised to do immediately. A policy of financial repression is not what the UK economy needs in 2017.

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