Cheap money, but only for a few

Governeor Mark Carney at the Bank of England shortly after his appointment in July 2013. Photo: Bank of England/Creative Commons

Our guest contributor Sam Juthani says austerity and ultra-low interest rates have trapped us in a dangerous loop of inequality and low growth.

For more than 20 years, the Bank of England has had clarity on the role it plays in managing the British economy — it controls inflation using interest rates. We have a target rate of 2%, and the Bank uses its considerable resources and understanding of the British economy to hit this target.

It was strengthened in this role in 1997, when Gordon Brown announced that it would become operationally independent. Instead of having to answer to the Chancellor for every interest rate decision — and therefore being influenced by short-term political concerns — the Bank would be able to simply do what it thought was the right thing to make sure inflation was on track.

But things have gone wrong — with our economy, and with setting interest rates. When the recession fully hit in 2008-09, the Bank of England, along with the US Federal Reserve and other central banks across the world, dramatically cut rates to help keep economies afloat. Desperate times called for desperate measures, and although the effects of the historically low interest rates were uncertain, the cost of not cutting them would surely have been catastrophic.

When the circumstances called for it, this loose monetary policy was made looser still, when quantitative easing (QE) was announced. This involved the central bank buying bonds (essentially, IOUs issued by the government or companies) held by financial institutions. This has the effect of lowering their long-term interest rates, and hopefully leads them to lend more money. It was a massive experiment but, just like the historically low interest rates, it needed to be done to prevent the British economy from choking up.

So with this massive monetary stimulus, are monetary economists happy? They are not. All the previous studies and experiences suggest that the US and the UK should be bounding ahead and that this dramatic, but temporary, experiment with low interest rates should come to an end so we can return to normality. That’s why Mark Carney, Governor of the Bank of England, and Janet Yellen, Chairman of the US Federal Reserve, have spent so much time since they took up their posts talking about when interest rates would rise. But, in August 2015, the Bank of England voted 8-1 to keep rates at their low level, dampening expectations that rates would rise this autumn, whilst Yellen has had to move her timetable for interest rate increases back in response to major financial shocks in China.

The wealthiest can take advantage of low interest rates when they want to borrow, and high rates of return on shares and property when they want to invest.

We need to get out of the low-interest rate trap, because it’ll catch us in a loop. We can’t raise interest rates because the economy isn’t strong enough to cope with the higher rates, but the low interest rates are causing a fundamental weakness in the economy. Low interest rates are great for borrowers but banks are being hugely cautious in who they lend to, so scarred are they by the crash of 2008. The best way of making sure that someone can repay a loan is by making sure they have plenty of money anyway. So the very wealthiest are able to take advantage of low interest rates when they want to borrow, and the high rates of return on capital, such as shares and property, when they want to invest. Meanwhile those who can’t borrow are squeezed more and more. And without a major groundswell of consumer spending, lending and borrowing, the UK economy will continue to grow in a lopsided way, becoming ever more unequal.

The problem starts, and ends, with fiscal policy – government taxation and spending. George Osborne’s cuts have hurt huge numbers of people, including the sick, disabled, young people, students and anyone who works in the public sector. But they have also done untold damage to the British economy by stopping us from returning to a state of growth and by damaging our productive capacity. The same story is true in America, where “sequestration” — automatic caps on government spending — forced hugely damaging cuts because the Republican-controlled Congress couldn’t pass a budget in time.

The Bank of England is supposed to use interest rates to control inflation at 2%, but in 2011 inflation reached more than 5%. Today, inflation is 0%. And the Bank of England has not touched interest rates at all, because to do so would cause the UK economy to crash — it would be deeply irresponsible. It is forced into this position because spending cuts are too deep, forcing people into unemployment, and wasting the precious resource of skilled labour.

All the talk on financial markets these days is about when interest rates will rise, and the potential damage that might happen if they rise too soon. But this Catch-22 situation, where low interest rates increase inequality and lower growth rates, and so make it harder to raise them, could be stopped with fewer cuts. If only someone would tell George Osborne.

  • Sam Juthani is a professional economist who has worked for HM Treasury and as a consultant to the World Bank. He stood as a Labour Party parliamentary candidate in May 2015. He blogs at