Neutral Interest Rates

Hmm, this is interesting.

The so-called neutral level of interest rates is now below 5pc for the first time in well over a decade, indicating that the Bank of England will be able to leave the base rate lower for longer in the future, a report from a key Treasury adviser has shown.

Neutral interest rates, which for most of the past decade had been thought to lie at around 5-5.5pc, are now around 4.5-5pc, according to a study by David Miles, a leading City economist frequently touted as a future Monetary Policy Committee member.

I wonder why he thinks this change has happened?

One thought is that LIBOR is now at a higher premium above base rate than it has been, so thus the same real monetary stance is achieved by a lower base rate.

Another would be that the UK has in some manner become structurally more flexible (say, some supply side reforms have worked) thus we\’ve raised the trend rate of growth. Thus we can have more growth in the money supply without there being inflation.

The third might be that we\’ve got deflation in some asset markets.

Number three is obvious but I\’m not sure what effect it would have on the neutral level of interest rates. One is obvious and does have an effect and two, well, anyone see the UK economy getting more flexible under this lot?

Anyone who actually knows why Miles thinks this way is welcome to correct my ruminations.

3 thoughts on “Neutral Interest Rates”

  1. “frequently touted as a future Monetary Policy Committee member”
    Anybody saying lower interest rates will get the nod from Brown.

  2. “Anybody saying lower interest rates will get the nod from Brown.”

    So who will we blame for galloping inflation? Brown the organ grinder, or the MPC monkey?

    It seems to me that the market is now setting interest rates, not the MPC: the massive Government borrowing to come coupled with higher inflation expectations means that the Debt Management Office will have to auction gilts at higher yields, with a knock-on for corporate bonds and wholesale mortgage funds.

    Tim adds: The market always sets long term interest rates. Base rate only influences.

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