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ISBN 978-1-906439-21-7

 

 

   

Inflation, interest rates, and common sense

UK inflation has risen in recent weeks and many economists think that the Bank of England Monetary Policy Committee will vote to raise interest rates when it meets on 9 May. However, much of the blame for higher inflation can be taken by higher oil and energy prices, and is not a result of increased discretionary sending on the part of consumers. Indeed, rises in non-discretionary spending (for example higher gas, electricity, oil prices, council taxes, and general taxation) act as a brake on consumer spending at least as effectively as higher interest rates.

Moreover, interest rates may not be as effective in controlling inflation as is generally supposed. Consumers who buy on credit with store or credit cards are unlikely to be deterred by a quarter percent rise in base rates when they are borrowing at APRs of 15% upwards. It’s also worth bearing in mind that for every borrower there is a lender: your rise in mortgage interest is my rise in savings interest. Higher savings rates might not feed through to higher spending on the part of savers, but they attract more money into savings. Banks and building societies offer attractive packages to borrowers to keep their loan books in step with the extra funds their higher savings rates attract, and go some way towards offsetting the negative impact of a rate rise.

The evidence currently is that consumer spending is fairly subdued. House prices on the whole are static. Intense competition for the supply of most consumer products has driven prices down virtually across the board. Products that only a few years ago were considered luxury items (LCD televisions, DVD players) can be picked up in Tesco along with the cat food. The things we choose to spend our money on are, on the whole, cheaper than ever. The things we have to spend our money on tend to be the ones that rise in price, and there isn’t a fat lot we can do about it.

 

  9 October, 2008 © 2008 K.R.Wade and Co Ltd prev page next page