INTERESTing Times

I’ve thought long and hard about this one over the past week……pondered, counter pondered and undertaken a number of significant head scratching sessions……and I think I’ve got my head around it. Kind of. Sort of. Definitely. Perhaps……

 

The Story……

 

The incoming Governor of the Bank of England (Canadian Mark Carney) has hit the ground running and launched a series of interest rate policies that have grabbed the headlines. Namely, that interest rates will not rise until unemployment in the UK drops to 7.0%.

 

Given that the current rate is 7.8% and has not fallen to 7.0% since 1998, this is a good thing right? Well, actually no.

 

The Science Bit……

 

The Bank of England’s remit is to control inflation so that the real value of money is not eroded in a boom / bust scenario (think Brazil, Russia). This is undertaken by manipulating interest rates. Where inflation looks to be increasing, they can put less money in our pockets by increasing interest rates and reduce how much we spend (thus inflation reduces as a consequence). Conversely, they can put more money in our pockets by reducing interest rates, we spend more and inflation rises.

 

But the new approach of linking unemployment to interest rates creates many problems. The list is huge, but here is my top 3.

 

Problem #1

The graph highlights that unemployment and inflation are not correlated. So in essence, we are using a measure to determine whether interest rates should rise / fall that has very limited value. Or to put that another way, we might as well use the direction of the wind as it’s equally as useful!

Problem # 2

The rate of unemployment is a political hot potato as every Government wants to manipulate the figures to reduce the headline rate and every opposition party wants to manipulate to increase it. The actual rate of unemployment is down to successful political slipperiness. Is this really the right measure to determine interest rates?

 

Problem # 3

We save less per head than any other developed nation in the world. When the real value of money is eroded if savings interest rates are lower than the rate of inflation, where is the incentive to save for the long term?

 

And I could go on and on……but you get the picture.

 

Well, it’s certainly a radical approach and couldn’t be any more different to the more traditional stance of the previous Governor, (far from) Marvellous Mervyn King.

 

Better the devil you know? We shall see.

 

Time will tell.