We should cheer further interest rate rises, not fear them

BY Andrew Lilico   /  13 February 2018

Political and economic analysts are starting to expect the Bank of England to raise interest rates a little faster than they had previously thought. The National Institute of Economic and Social research now expects rates to rise this May and then every six months thereafter until rates reach 2 per cent in mid-2021. With inflation not falling quite as fast as hoped in the latest data, markets are now starting to factor in faster rate rises. Similarly, on the political front, Conservative Home has argued that “The Government needs to present a persuasive explanation of why interest rates are set to rise further”.

It will be excellent news if interest rates are now going to normalise more rapidly. Economies grow fastest when interest rates are at what economists call their “natural” level — which is not the same thing at all as “the lowest level policy-makers can get away with”. At artificially low rates, firms can get away with using unproductive machines and methods for a while (which may be some considerable time in practice) because they have only very low financing costs to cover. When rates rise a little, firms are forced to be more productive and efficient, because they need to create greater surplus value so as to service their debts. That means that at slightly higher rates, the economy becomes more productive, wages rise and GDP grows faster.

Higher rates are also more socially equitable, because they result in a fairer division of rewards between savers and borrowers. Artificially low rates produce low returns for those that saved up in the past and instead reward those that over-borrowed. Higher rates return us closer to providing fair returns for prudence and thrift and force borrowers to think harder about whether they really want the things they’d like to have now and how they will earn the money to pay back their debts in the future.

A third thing that higher rates will do is to provide a more price-based rationing of credit, which will ultimately be fairer as well as more efficient. In recent years, state-subsidized banks have been subject to very tight regulatory restrictions on their ability to lend. When higher interest rates, rather than regulatory quantitative caps, become a more important determinant of whether money is borrowed and lent or not, whether one gets to borrow or not becomes more dependent on how good a risk you are and less on some more-or-less arbitrary feature of the regulatory ebb and flow.

Policymakers spent nearly a decade with a terror of what might happen if interest rates ever rose, creating a taboo against the normal rise and fall of policy making. That taboo was broken with the near-seamless November rate rise, which did not produce either an economic slowdown or financial turmoil. Bring on some more. Still gradual and careful, and still supportive (even 2 per cent interest rates would be the lowest rates ever were before the 2008 crisis). But back to normally supportive levels. We should cheer as they go up.