The banks think a post-Brexit economy can be saved by slashing interest rates – but reality doesn't back that up

Japan introduced negative rates earlier this year, but prices are falling faster than ever. It's possible that the idea an economy can be boosted by very low interest rates is just a case of misguided 'group-think'

Hamish McRae
Wednesday 27 July 2016 17:17 BST
Mark Carney, Governer of the Bank of England
Mark Carney, Governer of the Bank of England (Getty)

We now have a snapshot of the UK economy before Brexit. What does it show us, and what should we look for next?

The snapshot is the second-quarter GDP figures, which show the economy grew by 0.6 per cent during April, May and June. That is an annual rate of 2.4 per cent. Toss in the slower first quarter, when growth was 0.4 per cent and the pre-Brexit economy was growing at around 2 per cent a year. But since the vote the data has been at best uneven, and at worst deeply worrying. Bad purchasing manager indices last week have been confirmed yesterday by poor numbers in the CBI distributional trades survey for July, in which retailers report what has been happening to their business.

It has become clear that if you ask people whether things are better, the same or worse as a result of the vote, they almost invariably reply that they are the same or worse. Very few say they are better. In normal times these responses would be an early warning of at least a slowdown, maybe a recession. But these are not normal times and if you take anecdotal evidence from, for example, estate agents, there does not seem to have been much slowdown at all – expect in top-end London, where things were slowing anyway.

Further support comes from equities, where the FTSE 100 is now the highest for 12 months. Though allowing for the fall in the pound, it is only up a little – but that is nevertheless mildly encouraging. Put it this way: while I have yet to see a single economic forecast that suggests the economy will do better in the short-term as a result of Brexit than it would otherwise have done, the evidence so far is that the damage, such as it is, will not spread far beyond the UK.

So what next? Well, the huge question will be what happens to UK monetary policy. We may get some guidance, if not an answer, next week when the Bank of England’s monetary policy committee meets. The MPC generally moves when it has the additional data from the quarterly Inflation Report. This was started in 1993 when there was profound concern about the danger of runaway inflation. Now some have joked that it should have been renamed the Disinflation Report, but actually its next edition may well suggest that inflation will pick up in the next few months. Were it not for Brexit, an economy growing at 2 per cent a year and unemployment down to 4.9 per cent, it would warrant a rise in rates. Now the banks fear zero rates or worse.

Actually, the letter to business customers from NatWest and the Royal Bank of Scotland about the possibility of their being charged negative rates was probably intended as a shot across the bows of the MPC. Do that and you will be seriously unpopular. But it does underline the contrast between Europe (and now also the UK) and Japan on the one hand, and the US on the other. We are pondering dropping interest rates, they are pondering putting them up. Writing ahead of the Federal Reserve statement tonight, it seems the next rise in US rates is merely a matter of time.

This leads into the debate as to whether negative rates actually work. The evidence is thin. Japan has had a 25-year experience of near zero rates and that did little or nothing to boost the economy. Recently rates have gone negative, again to little obvious effect. In Europe they have been adopted by several central banks, including the European Central Bank, but it is hard to see if this has had much of a positive impact on growth. The eurozone, taken as a whole, is now growing, but we don’t know the counter-factual: what would have happened had the ECB kept rates positive. The theory is that they push banks to lend more, but it is not clear if this actually happens.

It looks as though we in the UK will discover next week whether even cheaper money has any effect. It is widely expected that there will be a resumption of quantitative easing (the bank buying bonds and in so doing pumping cash into the economy), a cut in rates to 0.25 per cent and maybe some other measures to push the banks to lend more. Whether this will have any impact remains to be seen.

And there’s the nub of the argument. Conventional central banking thinking is that yet looser monetary policy will boost the economy. But outsiders feel this is a case of “group-think”. All the experts seem to agree – so the policy must be right. But they talk only to each other. Quite a few economists are now arguing that this policy is ineffective, and sets in store huge problems for the future, including encouraging people to take on too much debt, and pushing bond yields to dangerously low levels.

One thing is for sure. This is a great economic experiment, carried out live in Europe and Japan, and maybe, thanks to post-Brexit fears, spreading here. Those of us who think that this will be seen as a huge policy error have yet to be proved right. But the Japanese experience is not encouraging. They introduced negative rates earlier this year, but prices are falling faster than ever.

The talk now is of “helicopter money”, the expression coined by the economist Milton Friedman to describe central banks spraying dollar bills from a helicopter to the people below in the hope they would go and spend them. It sounds absurd – and you know, if something sounds absurd, it is just possible that it is.

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