10 January 2014

Stick or twist?

There is an economic argument going on in the background.

Some pundits cannot wait to plunge us into trouble.  Like this one:
The Bank should be putting up rates now, in a gentle and gradual manner. The money supply is growing at a reasonable rate; nominal GDP is expanding  nicely; employment is soaring; wages of some professions (including brickies and architects) are shooting up; there are already some skill shortages; and the current account deficit is huge, suggesting that aggregate demand is too large compared to supply. Monetary policy should be forward-looking: decisions today have an effect with long and variable lags, so waiting until there is a problem is always too late. Sure, the UK economy remains smaller than at peak; but that will change before the year is up. It is a mistake to look merely at the macro effect of interest rates: the impact on big aggregates such as consumer prices, output or employment. The micro effect also matters hugely – the allocation of credit, capital and labour between different companies and all the myriad decisions that make up an economy are being hugely distorted by artificially low official interest rates. The economy is normalising – monetary policy must follow suit.
On the other hand, some take what appears to me to be a more sensible line:
Chris Giles at the Financial Times has argued that the Bank of England will have to raise rates soon, because recent job growth has been accompanied by low productivity -- a situation that could produce inflation unless the bank acts. The informal Shadow Monetary Policy Committee, which meets at a free-market think tank, has been calling for an interest-rate increase since February last year, when there was no recovery in sight.
What the policy hawks fail to recognize is how damaging a premature tightening could be. As Oxford Professor Simon Wren Lewis has noted, debt-service payments still occupy a large portion of households' budgets. In the absence of an adequate increase in income, even a small increase in interest rates could trigger defaults and foreclosures on a grand scale. Why would anyone intentionally precipitate such a crisis unless coerced by the prospect of rampant inflation?
Why indeed?

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