Political Promise

Now Is Not The Time To Raise Interest Rates

In Charles Maggs on January 27, 2011 at 5:06 pm

Charles Maggs argues that the interest rate should not currently be raised.

Today (Tuesday) saw the release of the latest and somewhat worrying GDP figures for the final quarter of last year indicating that the economy contracted by an alarming 0.5%. Coming on the back of Sir Richard Lambert’s criticism of the coalition’s growth policies-this was a very poor and somewhat unexpectedly bad news day for the government.

Recent consumer price index (CPI) figures put in inflation at 3.7% sparking many, including prominent Tory backbencher John Redwood, to call for an increase in the Bank of England base rate of lending. The Bank of England has been lending at the record low figure of 0.5% since March 2009 and the high rates of inflation meant Mervyn King had to send another customary letter to the chancellor to explain himself upon the release of the figures. 

The key question to ask when discussing how to cure the inflationary problem is firstly, which prices are rising and why? To raise interest rates traditionally curbs inflation because it tackles demand pressures on inflation. For example, it makes homeowners monthly repayments increase and so they have a smaller disposable income and so spend less. At the moment however inflation is being seen world wide and the economy here in the UK remains weak.

Take oil for example. The price of petrol in this country is exceptionally expensive and has been for many years, but the recent rise up to an average price of around 129.9 pence per litre is a result not only of the high tax burden on petrol but also because the price of crude oil has reached $100 a barrel, up from around $75 a barrel as recently as September last year. Petrol is of course key as all goods are reliant on petrol for transport, so if the price of oil is high, the price of everything else is affected.

Another area that has seen high inflation is food. Keeping the price of food under control has been impossible not due to the VAT rise (VAT does not affect food) but because of, as with all goods, supply and demand. As the global population increases, and many in the developing world are relieved of poverty, demand for food, especially meat, rises. Global weather has also been a factor influencing food price inflation. In Russia severe drought and fires led to the banning of wheat and grain exports from the country back in August which pushed the prices of wheat and grain up 12% in Europe.

In a time of rising unemployment and minimal growth, it is wrong for people to be suggesting that the Monetary Policy  Committee should be increasing interest rates because the inflation we are experiencing is essentially demand pull inflation. Ultimately the economic policies of the government are aimed at improving the living standards of the public and a rate rise would hinder this by reducing disposable income, as well as failing to tackle the causes of inflation.

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