I am a layman who has always been interested in economics and would appreciate knowing why these actions in regard the UK economy are not the right road to recovery and fly in the face (if I’m correct) to most that is advocated here?
The current policy of low interest rates that claim to help businesses to borrow money help manage that which they have and thus expand their business.
Further to this, with low interest rates you have a lower exchange rate making exports cheaper and building manufacturing businesses.
Businesses must be able to invest their savings preferably instead of being dependent on banks for loans. These savings are earned by making profits. Profits are attributed to businesses that supply markets that are undersupplied and where demand is high compared to costs of production.
What happens if inflation is used to lower interest rates? Business profits are expropriated, thus lowering investments by businesses whose markets are most undersupplied, and also extending the structure of production towards businesses whose markets would otherwise be oversupplied. In addition, higher costs for imports will reduce profits and reduce investment.
An artificially low interest rate doesn’t help in the long run. With a low interest rate, there is very little incentive to invest.
Interest rates are properly set by the amount of savings. If savings are high, then interest rates will be low, if savings are low, interest rates will be high.
As Cam said, interest rates are properly set by the amount of savings. When savings are high, and interest rates are low, it sends a signal to investors that people have money stored that they will be able to buy the products or services the investor is going to make. However, when the interest rates are artificially lowered, it sends a false signal to entrepreneurs. You get a boom, because they begin to start businesses (or expand existing ones) just as they would if there were real savings in the economy. However, when those products get to market, there isn’t enough savings to actually sustain the expansion, and you get a bust.
However, isn’t a lot of what you explained a way to successfully manage an economy before you have a recession? When in the midst of one could you please explain the best course a government should take in regard interest rates and a low exchange rate helping exports or is it much the same course of action?
It’s impossible for government planners to predict/manage an economy better than the market can (I believe Mises was the one who proved this), but the best thing that a government can do during bust times is to let the collapsing companies fall, lower taxes/regulations, and increase the interest rates. That’s exactly what happened after the recession of 1921 in America, and was a major contributor to the roaring 20s.
What Cam said. An economy cannot be managed by central planners sending false signals to the market by manipulating interest rates. The goal of central banks are to maintain full employment and to keep prices stable. The problem is, in a natural economy, employment and prices have to be able to adjust. The central planners, by manipulating the interest rate, convince everyone to continue consuming, even when there are no more savings to consume. When the inevitable losses come, from firms being short further capital to continue growing, and are forced to contract, the habit of politically motivated central planners are to restimulate the economy by forcing rates even lower and engaging in other schemes to force liquidity, and try to stimulate demand.
But no matter how much they stimulate, they can’t put more grain in the silo or pull more gas from the ground. Which is when you have an extended recession, or depression, or panic.
There is an excellent Tom Woods video where he explains this, and I highly recommend it for someone like you who is very new to this stuff. Woods is fantastic at breaking things down for the layman.
Apart from the brilliant comments other users posted there’s another couple of things to add.
Interest rates are at an all-time low, that’s true, but banks have become much more cautious when it comes to lending. Despite attempts at preventing the much feared “credit crunch” by political forces banks want to play safe (or at least safer than a couple of years ago… my bank is currently bound to lose hundreds of million euros from a botched public housing operation in Milan but that’s another matter completely) and are not as ready to lend to anyone walking through the door as in the past. Perhaps they are finally coming to their senses.
Then there’s the question of savings. Despite proper monetary inflation Europeans (Britons included) are still savers, though not as formidable as Asians. Problem is saving right now is being discouraged by the same monetary policies of above: ever since the '80s I’ve experienced steadily falling interest ratings, to the point that last year they were well below the official inflation rate (really a much watered down CPI). Back in the '80s you could just put your money in a bank and you would get a nice interest rate, zero risks and no strings attached. Right now to get half of that interest rate you either have to be a smart gambler or bind up your savings for many years, something in the present economy I am not prepared to do. How is people supposed to save when saving actually costs you?
Finally there’s the problem of the manufacturing base. Though it’s not as easy as in the '60s starting a nice manufacturing business is still possible, provided you pick the right sector, stay small to avoid the worst labour laws and choose a place with decent infrastructures. But then again why bother? You can just have your product engineered and designed here in Europe and then manufactured by a contractor in China with much less hassle. Even when import tariffs are taken into account you’ll still be able to offer a competitive price and Chinese are working hard to improve the quality of their products.
