About Mon, 12 Jan 2009
UK official interest rate at 315 year low
Last week, the UK reduced its interest rate to the lowest level ever in its 315 year history. I found this surprising since there is very little in terms of economic environment that the Bank of England has not seen in these three centuries. It is all the more puzzling when the interest rate graph is juxtaposed with a graph of inflation rates (see figures below).
It is interesting to see that negative inflation rates are quite common prior to the twentieth century. The average inflation rate was negative in the entire nineteenth century. But even in this period, while interest rates went down to 2% on several occasions, they never dropped to the 1.5% level reached last week.
What is also interesting is that for 103 years from 1719 to 1822, the Bank of England did not change its rate even once. England lost an empire in one continent while gaining an empire in another; it fought the Seven Years War and the Napoleonic wars; inflation rates ranged from +30% to -23%, but interest rates remained fixed at 5%!
Deflation was quite common in the eighteenth and nineteenth centuries, and apparently was not damaging to growth. Perhaps, there is something pernicious about fiat (paper) money that makes inflation and deflation so scary. Under the gold standard, the price level had a tendency to mean revert so that high inflation was followed quickly by deflation; therefore even 30% inflation did not create inflationary expectations, and even 20% deflation did not create deflationary expectations.
Posted at 13:17 on Mon, 12 Jan 2009 5 comments permanent link
Comments...
Mahesh wrote on Mon, 12 Jan 2009 14:59
Re: UK official interest rate at 315 year low
austrian economists have been demanding reverting to gold standard for quite some time and this has even inspired and/or influenced politicians ( like Congressman Ron Paul in US)across the world. What would be your opinion on the rationale given by the Austrian group (mises.org has some good articles)regarding adoption of gold standard. Is there any ( I want to stress here , ANY) disadvantage for economy at large by this move.
Pravin wrote on Mon, 12 Jan 2009 19:22
Re: Re: UK official interest rate at 315 year low
Mahesh,
Going back to a gold standard would entail limiting govt control over money supply. This clearly means that those in power have to sacrifice a lot of their power over deficit financing and all that comes with statist planning. I dont see that happening in India or anywhere else unless there is a bloody (violent) revolution.
Prof Varma, Thank you for pointing out that though bubbles did exist even in a gold standard system, they were short lived.Also, it would be instructive to see what caused those periods of inflation -was it gold discovery in the new world?.Was it govt going off the gold standard and indulging in fiscal imprudence(eg wars).Ditto for deflation.
I think it is obvious that in gold standard,money supply being almost constant,a steady fall in prices on account of productivity growth is natural. So a beneficial deflation(in price terms) need not be a bad thing(we all want cheaper TVs/PCs every year -but the TV/PC producers dont get bogged down by that thought and stop investing). Bwtwn 1870-1914 the US experienced (with the g/std) constant deflation but the highest economic growth.It was probably the best period of economic growth in the emerging US.
Mahesh wrote on Tue, 13 Jan 2009 11:05
Re: Re: Re: UK official interest rate at 315 year low
Pravin, I agree completely to what u suggested in your first para as reply to me . But I am afraid My question was not about how to revert back to gold standard or whether India ( for that matter any country) would be able to adopt gold standard at all. The question to Prof. was whether he agrees to the rationale given by Austrian economists at all. If he agrees and lot of other professors and intellectuals dont see any errors and hence no issues with gold standard at least in principle, that itself would amount to a minor revolution, sans bloodshed, ideology, marches , rhetoric, speeches etc.
Prasanna wrote on Tue, 13 Jan 2009 10:59
Re: UK official interest rate at 315 year low
Prof. Varma, your comparison of historical inflation trends and interest rates is interesting. Perhaps what is missing is the trend in debt/GDP ratios - private and government? Under the fiat money system allowing excessive build-up of debt - particularly private sector debt - is what makes deflation such a political hot potato. Even Minsky makes the point that investment led growth funded by public sector debt is preferable to allowing private sector debt go out of bounds. What is pernicious about the fiat money system is that the system cannot resist the temptation to overextend themselves when the going is good. Even if they are nominally independent, central bankers are not immune to this temptation.
harshendu wrote on Tue, 13 Jan 2009 13:35
Re: UK official interest rate at 315 year low
I agree with you... infact, the US interest rate stativity during the year 2000-03 and its sudden rise onward 2004 caused much dissensions within the housing mortgage market. As also, the UK have had experienced high Inflation pre Thatcher era, durin the 1974-78.
It seems that the global market is influenced by Financial Heterodoxy, as this new concept eclipsed the current investor behavior in the US and elsewhere. And.. the interest and Inflation rate equallyv played the spoilsport. But good news for the stock borokers! a formula for calculating closing value have been invented using Risk function curve equation... but its too complex either...
