Inflation rates and interest rates. Can someone explain the logic?

Milton Friedman could.

Ernie you right in your assessment of Tory policy, it will benefit their voters more than the alternatives, unfortunately it will crucify most other people. The alternative isn't great either, subsidies now (which everyone will end up paying back) or wage increases that will continue the inflation spiral even if fuel prices drop.

I honestly dont know what the answer is, on a selfish personal level Tory policy works for me, my income combined with personal circumstances mean I can weather the storm (as long as I stay in work) and I don't want to be paying for the current crisis over the next 15 years as i try to save for retirement. However its not going to be so great if im okay and most of the rest of society has collapsed. Not much point worrying about retirement if the economy has collapsed, the hospitality sector is gone, homelessness is endemic and we can't afford basic services such as the NHS. I can see that whilst on the surface Tory policy might seem good for me I don't live in isolation so dont want to see the rest of society go down the tubes. Unfortunately most Tory voters won't. I'm not a Tory voter before you ask, voted for Labour under Corbyn in the last GE and will vote for anybody but the Conservatives in local elections. Being small c conservative doesn't equate to bein Tory.

Haven't we done lots of this in similar threads?

The unspoken thinking here is that the central banks are making money expensive and slowing economies deliberatily to help recession along - at the price of job losses and poverty.

The recession will almost certainly indirectly calm inflation (which would have probably tapered off when supply chains started to level out.)

Raising interest rates to do all this is utterly criminal, and absolves Governments themselves of their own solutions. It's just easy to pass the responsibility to the BoE and blame them of course.

All this demonstrates is that there was never any forward thinking for just in time supply chains and the like and short termism has bit us on the arse.

Interest rates have no direct correlation with CPI (given supply issues) in this scenario but the wider picture is an expected slowdown that has almost been engineered.

The point being - spread the responsabilty amongst the population rather than the big earners and wealth hoarders who helped create this situation.

There will be many suprises I fear along this journey and doing what they are doing will produce more devastating shocks than the central banks have planned for.

You can see the central bankers making everyone aware of recession ahead of time - as we know boom and bust definitely benefits the ruling classes and this is what we are seeing here.

But on top of all this lot market failed utilities and infrastructure issues are at sea and no solutions there.

This downturn is complex and isn't a simple return to boom one I feel.

The state has to generate the real wealth to grow the economy. But decisions are built around the private sector generating growth - how's that happening with increasing interest rates? It's all back to front.

IANAEconomist
Inflation is a rise in the price of goods and services and if it's sustained Governments want to control it.
2% is a rate that's applied here and in the US because you don't want too much inflation, but you also don't want deflation.
Interest rates are a blunt instrument employed to maintain that set rate but the problem is that inflation has to be sustained before interest rates are deployed and, as I said on another thread, they consequently get used too late and tend to be eased off too early (that's history, not economics)
Increased interest rates mean that we spend less on things that need financing by loans and banks are less likely to loan you money anyway because you might not be able to pay it back. If fewer people can get a mortgage then fewer people buy houses and the prices don't rise as fast.
The signal is one of contraction, but that knocks on to employers considering expanding and employing more people, etc, hence my assertion that it's a blunt instrument
Crossed-post with rone

Its not really about micro economics (mortgages/savings), a lot of the need for increasing interest rates is macro economic policy (international trade).

The pound is very poor against the dollar, which needs to be corrected.
Energy (oil) is traded in dollars so half of the reason prices are increasing is the pound is worth less.
Increasing interest rates will help address that international issue, but making the pound more attractive.

Interest rates have always needed to rise back to historic level (4-5%) to correct a lot of other issues within the economy. Unfortunately people have gotten used to cheap debt, and now its becoming painful when everything corrects.

Increasing interest rates will help address that international issue, but making the pound more attractive.

Given major economies are raising interest rates across the board and the fiat currencies are traded depending massive external factors - I can't see this being any sort of given.

The BoE mandate is to control inflation by the way.

Unfortunately people have gotten used to cheap debt, and now its becoming painful when everything corrects.

Agreed, but again engineered this way because wages are so low. There is no choice living in an expensive country but to get into debt.

As I see it, it’s that economics has been regarded as a science,

It's probably on a par with macro-biology. Lots of trying to model a very big complicated system and trying to model it on a graph with only two axis. So there are lots of "interest rates Vs inflation rates" type explanations, where one blunt force impacts on another, whilst hundreds of other factors also have impacts that probably exceed the margin for error.

The thing is, we've had some inflation, despite near zero interest rates for a decade, and wage growth has been zero to low in GBP terms, and highly negative in international terms (convert your wages over the last couple of decades into dollars or euros if you want to be depreseed, or look on job sites for your job abroad).

If people think that wage inflation will cripple the economy somehow then they really should be asking, why is the economy in such a bad state that it can't afford the same wages as other similar countries?

'The recession will almost certainly indirectly calm inflation'
A recession in the UK won't do much but a recession in China will, as that will cool global demand. Comes with some nasty side effects tho'.

The UK economy isn't big enough to impact global or even European energy prices

Funniest thing about economics is when people who watch the news think they know more than people who've been studying it for 20 years.

The particular lack of logic is the BoE on one hand increasing interest rates and aiming to discourage spending and lending, and then the government constantly making plans to help people financially, reduce tax etc, which will have the opposite effect. I get that there are larger issues at work but it seems ridiculous for the two to basically be talking about doing things which will have opposite effects.

@molgrips

Behave if we had a stance like that on here what would everyone do? The politics threads would be empty

The UK economy isn’t big enough to impact global or even European energy prices

Yeah and US are doing exactly the same. That's the point

Funniest thing about economics is when people who watch the news think they know more than people who’ve been studying it for 20 years.

Okay the flip side is neoliberalism- from classical economic thinking, and tax and spend has done more to harm to people in the last 20 years as we're currently discovering.

So yeah it's time for a better model or clearly our experts are not acting in the best interests of the many.

get that there are larger issues at work but it seems ridiculous for the two to basically be talking about doing things which will have opposite effects.

You've discovered the farce that is fiscal and monetary policy fighting each other.

The government could and should take charge of the BoE but currently it's a handy patsy.

Funniest thing about economics is when people who watch the news think they know more than people who’ve been studying it for 20 years.

If economics is such an exact science then why do so many economists disagree with each other?

If economics is such an exact science then why do so many economists disagree with each other?

Given classical economics has delivered this shit show and spends all its time papering cracks with illogical solutions designed to serve about 50 people - then I can't see how Heterodox economics can't be given more weight.

I mean it's not as if we lack good examples of broken markets and institutions, as well as society itself.

Funniest thing about economics is when people who watch the news think they know more than people who’ve been studying it for 20 years.

There is no right or wrong in economics, only priorities.

Milton Friedman and Paul Krugman both studied economics for more than 20 years, and each won the Nobel Peace Prize for economics, yet came to quite different conclusions.

The standard right-wing solution to inflation anything is that working people should pay the cost

FTFY

The government could and should take charge of the BoE but currently it’s a handy patsy.

Oh great, economic decisions being made for political reasons. That always ends well! One of the best thing Gordon Brown did was to make the BOE independent. The manipulation of interest rates by politicians caused all sorts of mayhem as I recall. Interest rates move up 5 percentage points in one day (boa knows down again too I think) if I recall correctly.

Oh great, economic decisions being made for political reasons.

Isn't that the whole point of having elected politicians? Leaving things to the market to sort out isn't really an option.

As for the Bank of England's "independence" it shouldn't be exaggerated, ultimately the BoE is responsible to the government, and it is the government which sets the inflation targets, not the BoE.

Oh great, economic decisions being made for political reasons. That always ends well! One of the best thing Gordon Brown did was to make the BOE independent. The manipulation of interest rates by politicians caused all sorts of mayhem as I recall. Interest rates move up 5 percentage points in one day (boa knows down again too I think) if I recall correctly.

Ah this old chestnut.

The BoE are owned by the UK government, - the MPC appointed by the chancellor. Following a mandate set by the government for a 2% inflation target.

They also perform Q/E under instruction from the government/treasury when needed.

Seriously how politically independent do you think they are?

What sort of mayhem can be worse than shit that is going down now - as they make money more expensive in a down turn whilst basically having no control of inflation.

Inflation targets have become an almost meaningless drive at the expense of other problems in the economy. After all economists can't even figure out why 2% was even the target!

The BoE's 'independence to adjust rates' exists to contract responsibility away from the government whilst being an arm for government policy.

My favourite paragraph on this:

"The Bank of England is independent of the government so long as it does what the government wants. The Bank of England Act of 1998 provides a Chancellor with the option of overruling the decisions of the Bank of England."

Isn’t that the whole point of having elected politicians

Given the frankly piss poor understanding of economics of the average politician I’d say no.

The point of the independence is to give them a long term task (control inflation sun this case) and leave them to get on with it without being distracted by immediate day to day distractions, like maintaining currency value! If the politicians want to change the task, fine, but day to day control; bad idea in my opinion.

And if you think politics are kep out of it - the 575,000 salaried Governer Baoley was urging wage restraint for us minions for inflation concerns that isn't actually being driven by wages.

Capitalist and ill-informed whilst doing very well thanks.

The point of the independence is to give them a long term task (control inflation sun this case)

It's not independent as explained and they're not in control of inflation.

What we need are better political and economic choices.

Isn’t that the whole point of having elected politicians

Given the frankly piss poor understanding of economics of the average politician I’d say no.

So you don't think that politicians should interfere with the market and just let them get on with it?

Have you thought about this?

https://www.goodreads.com/author/quotes/5001.Milton_Friedman

“Government has three primary functions. It should provide for military defense of the nation. It should enforce contracts between individuals. It should protect citizens from crimes against themselves or their property. When government-- in pursuit of good intentions tries to rearrange the economy, legislate morality, or help special interests, the cost come in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player.”
― Milton Friedman

If economics is such an exact science

It isn't "Economic Scientists" have predicted 11 of the last 3 recessions. The O|ctopus predicting the football results had more science.

It should provide for military defense of the nation.

If all activity is in the hands of the private sector then I don't understand why something as deeply complex, and expensive, as the defence of the nation, should remain in government control.

The war in Afghanistan, for example, could have gone out to tender with competition to between private owned armies to achieve the government's stated aims.

Remember Milton Friedman is arguing that absolutely everything, including health and education, should be privately provided. The only exception he makes is police and defence but I don't know why, already the private sector owns prisons it can't beyond the realms of possibilities for the police and defence to also be provided by the private sector.

When government– in pursuit of good intentions tries to rearrange the economy, legislate morality, or help special interests, the cost come in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player.”

What he's saying is technically not accurate with Fiat currencies and central banks - the government and central bank spend money into existence without which the private sector would collapse. It must spend to create new money.

Separate the state from the economy and the only money that would exist would be commercial bank loans. (Which are backed by reserves provided by the BoE.)

I said this the other day when the Commercial Banking sector collapsed did it bail itself out?

If all activity is in the hands of the private sector then I don’t understand why something as deeply complex, and expensive, as the defence of the nation, should remain in government control.

Because they're the only ones with the perfect spending capacity to provide it.

USA approaching one trillion dollars per year.

Who else would backstop that?

Always money for Wars.

It isn’t “Economic Scientists” have predicted 11 of the last 3 recessions. The O|ctopus predicting the football results had more science

Recessions are tricky to measure, sort of - because the revised figures they announce tend to get adjusted quite a bit from the original numbers over time.

If economics is such an exact science then why do so many economists disagree with each other?

If economics is so complicated that people who study it all their lives can't agree, how come so many armchair pundits think they know the real answers?

@molgrips it's more of an opinion thing as it's an inexact means of explaining how money moves around the economy. It's science insofar as a good economist will change their opinion in the light of new evidence. Unfortunately we are lead by people with all the economic nous of my dog!

I agree. I understand a little about economics and I know that it is simply a tool to describe what affects what. What effect you actually want to see happen is really a question of politics.

Because they’re the only ones with the perfect spending capacity to provide it.

Both health and education each costs the United States more than defence does, and yet Milton Friedman argued that the government should not be directly involved in health and education.

Besides, the government would still write out the cheques for the costs of defence and policing, but like the privatised prison service, for example, the government could opt for the most competitive tender.

It sounds hypocritical for someone with such an extreme and total faith in the markets to exclude defence and policing when they believe absolutely everything else, including education, should be provided by the private sector.

You can only imagine why someone would want the armed forces and police to be in the firm grip of the government in Friedman's dystopian world.

What effect you actually want to see happen is really a question of politics.

Which is why there is no right or wrong in economics only priorities.

One of the most famous quotes ever from a Chancellor of the Exchequer:

"Rising unemployment and the recession have been the price that we have had to pay to get inflation down. That price is well worth paying."

Was he right or was he wrong? Well it completely depends on your priorities.

He simply stated his.

@molgrips don't forget we do have models to describe things such as MMT where it demonstrates that the governments spend first but there are still vast amounts of people and economists believe we have to tax first to spend.

Things get repeated over and over and somehow become truth.

Which is why there is no right or wrong in economics only priorities.

Definitely.

As a society we have to choose which metrics we want to improve and let's face it there are plenty of them.

But with so much manipulation and agenda of statistics it's very difficult to find the right path.

For instance I wouldn't believe a word the OBR ever said. Yet the establishment use it all the time. It's handy to keep a lid on public finances for capitalism to thrive. But it's not so great for the poor and wider society.

If economics is so complicated that people who study it all their lives can’t agree, how come so many armchair pundits think they know the real answers

I think that applies to lots of things especially in politics.

But also people look at what's happening now and perhaps start to realise that the faith they put in the system isn't delivering their needs.

More and more middle class about to take a hit. They've not really known a downturn where they feel this sort of pinch. Lots of my friends who fit into this category believed that capitalism has served them well especially with cheap debt and some decent wages. But now they're expenses are getting hit in a way they didn't see coming. Very much a product of the system they endorsed.

And what happens if the housing market takes a hit ? - many a wealth will be destroyed for this particular group who built their existing on rising house prices.

The middle classes make up a lot of useful voters. This will be key to Tory handouts.

To me, it's all ready part of the fabric the working class get shafted but when the system works against its supporters then things will crumble.

To what extent currently I don't know. Depends on what governments do to fix things.

Market ain't fixing itself that's for sure.

One other separate point.

Macro and microeconomics are on a bit of a collision course at the moment.

That's an interesting scenario. I think the person in the armchair has good cause to comment.

Which is why there is no right or wrong in economics only priorities.

That's a better way of saying what I was thinking yes.

The system is about capital exploiting labour. Economics isn't neutral, you have to take a side in your perspective.

Economics is the one-page instruction manual for piloting a glider with a joystick made out of ham.

Levers such as interest rate changes are only slightly effective in normal conditions, where you can accept the lag between policy change and outcome. In the current supply-side storm, I doubt you will even notice the inputs.

It's not a question of removing discretionary spending from the economy, I think we are heading for a situation where many middle-income households will just choose where they default on existing debt - do they stop paying credit card bills, energy bills, other loans or mortgages? Raising interest rates just tips more households into multiple defaults.

When, in January, people en masse stop paying their energy bills, will the government step in to prevent disconnections, and prop up the providers?