All entries for Thursday 05 March 2009

March 05, 2009

Cutting interest rates was never going to work

Writing about web page http://news.bbc.co.uk/1/hi/business/7925620.stm

The Bank of England has, as expected, cut interest rates again by half of one per cent.

I’m no economics expert but I was never convinced that the repeated cutting of rates was ever going to work. Try it once, by all means, and on a small scale but this repeated chopping in my opinion has done no one any good.

The original idea was to make it cheaper for the main banks to borrow money from each other and on the surface the rate cut would reopen the gates of liquidity. The unintended consequence of this, however, was the swift flight of overseas money to more lucrative havens overseas. The clear indicator of this has been the plummet in the value of sterling as the investors have dumped the currency.

The effect of this has been twofold. First of all, there is less money than ever moving around the City but, secondly, the remaining industrial base of the nation has been hit by the rise in its export prices thus making it less competitive than ever and then to increase the price of oil in this country which had been dropping in recent months and and, well, have at least softened the blow had it not then been made to rise by the falling value of sterling.

The medicine has not gone down well. I wonder whether cutting the rates was ever going to work and whether a small increase of a quarter of a per cent at that point would actually have worked better. While other countries dropped their rates, overseas capital would have flooded in to the UK giving the central banks something to lend, thus increasing the liquidity in the market. And, assuming that Government went ahead with its ideas for forcing the banks to lend to industry and small businesses had still gone ahead, these businesses could still have been kept afloat. Additionally, we probably wouldn’t have seen taxpayers money being used in quite the same amounts had the banks had overseas money instead to invest (more wisely this time around, one hopes) and trade through their losses.

Had my idea not worked, then they could still have tried cutting the rates. In other words, they would have had somewhere to go. As it is, they have to print more money. Give it a fancy name if you want, but that’s basically what it comes too. And losing control of one’s currency has never been a good idea when it comes to stability.

Just ask the Romans. Or, more recently, the Argentinians.


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