For some time now savers have campaigned for a return to normal interest rates, by which they mean central bank rates more like 4%-5%. And it’s not just about earning more on their savings. This protest against the current 0.25% base rate also has a broader, altruistic bent. At least that is what they honestly believe.
They argue that higher interest rates will restore a lost balance in the economy – taking it back to the way it was before the financial crisis, when things were so much better.
And why wouldn’t they? Plenty of mainstream economists express the same concerns, including policymakers at the Bank of England, the International Monetary Fund, the OECD and the World Bank.
After several years of year-on-year growth, runs the argument, higher interest rates will deter banks, insurers and even hedge funds and private equity funds from taking excessive risks to improve their profits. Low rates mean they need to generate huge volumes of business to make the equivalent profit, forcing them to embrace sub-prime borrowers, as they did in the early part of the century to such disastrous effect.
A higher return on lending will strengthen the banking sector’s financial standing and give them the funds to spur investment and help in the all-important task of improving the nation’s output and productivity.
At the same time, higher interest rates will benefit ordinary investors. With a cute and cynical emphasis, the focus is on the ordinary investor because they can be said to be deserving of everyone’s support – especially those who put money aside in a pension. Who can argue against higher interest rates if they prevent the collapse of final salary pension schemes?
At the International Monetary Fund’s spring meeting this week, managing director Christine Lagarde is expected to highlight how another decade of ultra-low interest rates will depress growth and pose dangers for global financial stability.
The IMF will warn that risks to growth remain on the downside as low interest rates sit in the column marked potential disasters alongside Brexit, Donald Trump’s emotional response to presidential decision-making, and Vladimir Putin’s drive to undermine western democracies .
In a report last week before the gathering, which will give Philip Hammond a chance to catch up with his counterparts from around the world and countless central bank officials, the Washington-based lender of last resort said low interest rates in the UK, US and Europe meant the west was heading in the same direction as Japan and faced the prospect of decade after decade of low growth. It backed the savers’ argument that if there was much more of this, the developed world’s pension funds would be in jeopardy.
But the IMF, like the influential Bank for International Settlements (BIS), which sits in judgment on the policies of central banks from its Swiss headquarters, can’t find a way to get from a low-interest-rate world to one where base rates are 4% and mortgage rates 6%.
One problem is that they cannot agree on the reason for the current predicament. Claudio Borio, head of the BIS, made a stab at it earlier this year. He rejected the argument put forward most forcefully by Larry Summers, the former US Treasury secretary, that baby-boomer saving, excessive by historical standards, has created a mismatch of supply and demand in financial markets and that with a surfeit of funds chasing a handful of investment opportunities, it was inevitable lending would yield low returns.
Higher taxes on wealth and stratospheric incomes are the answer to this trend. It would allow governments to upgrade their crumbling infrastructures with cash, and reduce their need to borrow – something Borio worries is at its limit. He accepted much of Summers’s thesis, but favoured those who say a better explanation is the weakness of the banks following the financial crisis and subsequent steep cuts in interest rates.
However, the BIS, like the other international economic organisations, is impotent when urging that higher rates are a cure for the ills besetting the west, and to some extent the developing world.
Many Brexiters argue that quitting the European Union provides the economic reset needed to achieve a better balance, at least for the UK. A permanently lower pound could spur growth and employment, and combined with lower immigration, could lead to higher wages. In response the Bank of England could justify putting up interest rates, and allow the economy to support a thriving banking sector that in turn supports a Goldilocks economy – that is neither too hot or too cold.
Unfortunately for the Brexiters, a currency devaluation is also the option favoured by China, the eurozone and the US as a route to stronger growth and higher interest rates. Donald Trump’s call last week for a lower dollar shows that he is thinking the same way. With everyone pursuing the same goal, there is little chance of lasting success. So we are left with keeping interest rates low, probably for another decade.
While Lagarde (and her contemporaries) could accept the logic of wealth and income redistribution as a route to rebalancing, that seems unlikely. She is a rightwing politician with a final salary pension.