Interest Rates

[Big Al1st]

On the news it said that inflation had risen and therefore it was highly likely that the Bank of England will put up interest rates in the near future. It also said in this article that the cost of living rise was in main due to higher oil, gas and electricity prices which in turn is affecting shop prices and manufacturing costs.

As these increases are outside of our control, surely by putting up interest rates then inflation would rise even further. This in turn will lead to more job cuts as the market place is having a hard time anyway ( car job, shop jobs NHS jobs ect disappearing) which in turn will place a heavier burden on the treasury with less income and more to pay out in benefits, causing possible tax rises, which will increase cost of living.........

My head hurts! Can somebody explain the logic behind this when the increase in inflation is outside of our control. Should we not try and stimulate economy and manufacturing in order to compete with Far East.

[flip-flop]

The way to stimulate the economy is by lowering taxes, particularly corporation tax - income tax for businesses. If a company is paying less to the treasury they will have more to spend on investing in their business to try to compete with foreign producers.

[Loosehead]

Leaving aside the content of the RPI calculation for a minute. The index is designed to indicate the cost of living, all the prices in it are out of our direct control but they none the less do effect the cost of living. Rising prices mean more pressure will be put on employers to raise wages this in turn would increase money supply this is an upward inflationary pressure.

More money in the system = more spending power = rising prices = higher wages = more spending power etc etc ad infinitum.

The earlier this cycle can be arrested the less painful it is, the favoured weapon in a property owning state such as ours is interest rates, ie less money to spend, over time will halt the situation.

It does not matter if the cause is outside of our control it can still do damage and we must therefore react.

Thankfully one of the few good things this goverment has done is to give control of interest rates to the Bank of England who will not be affected by political considerations and will therefore not balk at raising interest rates if necessary even if unpopular.

[Big Al1st]

HI Loosehead, Great answer but..... surely the increase in petrol, gas and electricity will take money out of the system. I had a 2.5% increase in my pension yet my gas bill has gone up 32%, electricity 12% and Council Tax 5%. This has had the effect of taking my money out of the system.

What is less painful, people taking less increase in salay or interest rates going up which affects people like first time house buyers and people with young families?

[jake-the-peg]

When

[jake-the-peg]

Sorry about that.

When interest rates are low people borrow more money and buy more on credit.

More spending = more demand.

As we know high demand, creates high prices = high inflation.

Drop interest rates to say 0.5% and what do you think would happen to house prices?

[Big Al1st]

Jake, same as loosehead, great answer but apart from the fact that inflation is going up due to the outside influences raising the bank rate must have a detrimental affect on industry, and the retail sector. We are already having problems competing against Asia. Will this not lead to a slump leading to great unemployment.

I dont want to hog my question but is'nt there an argument that sometimes it maybe necessary to "bend the rules" slightly and to at least keep the interest rates low until the outside factors like energy stabilise. We have already been warned that gas will go up again.

Everyone has to use gas and electricity and upto a point fuel. Industry has enough pressures without additional ones imposed on it.

I will shut up now but I feel rather strongly about it, but thanks for your input. I now understand the theory behind the Bank's thinking but are they right at this point Rgds and take care

[Loosehead]

Your observations are valid, the overriding point though is that econimically Inflation is like a nuclear bomb the other considerations are considered secondary. There are other tools to control inflation but the one most appropriate to our economy is interest rates.

[jake-the-peg]

One of the problems with "stimulating the economy" is you have to be careful how you do it.

Margaret Thatcher had a great theory as I recall called "Trickle-down"

You gave big tax breaks to high earners who would respond by investing more in British industry and buying products that would stimulate the manufacturing sector.

Nope they all said "Ta" and bought luxury German cars and went on foreign holidays!

Duh!

Personally I doubt that our manufacturing industry can effectively compete with the Far East except possibly in high tech areas although even that's dubious.

In the long run I think economies are very complex and we all over estimate the amount of control that politicians have to influence them.

A bit like a ships captain with an axe - he can try to steer with it - and may have some effect, but all he can be sure of is his ability to sink it.

[chatchy]

Inflation is a ratio between productivity and availability of money. Government, by manipulation of the money supply controls inflation. Interest rates are only one method of controlling the money supply.

Inflation IS controlled by the government through the control of the money supply. Raising interest rates makes money more expensive and reduces the availability of money and therefor reduces inflation, less money chasing the same amount of goods and/or services.