Real interest rates already are negative

Today it was announced that the Deputy Governor of the Bank of England was considering lowering the base rate further still, beyond the current 0.5% into negative terrority.

Quite how this is supposed to solve our economic problems isn’t clear. Real interest rates already are negative for millions of savers, who are suffering from rates below inflation. Borrowing rates for home hunters and businesses are at record lows, would another cut really encourage a higher take up of loans?

The Keynesian mindset inhibited by those at the Bank and the Treasury continue to focus on the fallacy that simply encouraging more spending and more borrowing, regardless of where the money goes, will revive the economy.  Consumers and businesses are leveraged to the hilt, most are very wary of borrowing more when their job or profits are so uncertain. Banks are likewise worried about the soundness of borrowers, and would prefer to sit on the money. Taking interest rates negative won’t change any of these views, they will just make it more expensive for banks to sit on their deposits. But they are already facing a large opportunity cost by not lending. Earning 0.5% on deposits at the bank represents safety, not profit. Negatives rates would not change the outlook on the economy that has resulted in banks holding onto money. They desperately need to recapitalise – memories of Lehman Brothers are still fresh.

Further fiddling with interest rates won’t solve anything. It will continue to penalise the prudent, create malinvestments and further delay the day of reckoning, not prevent it.

The bank needs to recognise the reality of why banks aren’t lending, and why consumers are paying down debt. Rather than trying to change this behaviour, they should be encouraging it as the (painful) process of fixing the problems from the boom period. Encouraging more personal debt and risky loans just sets us up for another crisis later on.

We need to rebuild our economy on a sustainable path. This means ignoring all calls for short term, feel good fixes. Economies grow when producers are working in harmony to provide the goods and services consumers want. Stimulus packages, QE, and low to negative interest rates all harm this process, by redirecting investment to projects that consumers are not willing or able to pay for.

These fallacies of modern day central bankers have been refuted for decades, by the likes of Bastiat, Mises, Hayek and Rothbard. Paul Tucker would do well to study them.

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