Getting the effect the wrong way around again

As the evidence of the previous chart shows, the line continues almost flat after 2001. We have in that case had the longest period of price stability in UK history. But what is apparent is that whenever there has been an inflation hike there is always very soon afterwards a substantial fall. Too often that actually resulted in deflation – which discourages economic activity. Thankfully, we now avoid that. But there are three key issues to note, and I will concentrate on more recent history whilst nothing the longer trend.

Guess what? Not one of those three key issues is that possibly an independent central bank is a good idea? Or even, that the BoE continually changing interest rates might have had something to do with this.

Sigh.

But this is worse:

Even if interest rates go up there is actually no reason why interest costs on this quantity of debt owned by the government need go up: the Bank of England need not pay base rates on the central bank reserves accounts held by UK clearing banks with the Bank of England as a result of QE: the existing rate could be maintained if desired and there is literally nothing those banks could do about it. Why they need a windfall gain of billions from an interest rate rise is very hard to work out and anyone having the political courage to oppose them would seem to me to have an open political goal to aim at by opposing that benefit going to banks.

No. So, assume we do start to get general inflation as a result of QE and the increase in the money supply. That is the form of inflation that would be treated with interest rate rises after all.

OK. So, those bank reserves at the BoE. Currently the banks aren’t too worried that they’re not lending them out. Interest rates are titchy so why take the risks? Park then at BoE, make a little and be happy.

Now we raise interest rates but not those at the BoE. So, what do the banks do? Scramble to withdraw those reserves and lend them out. Which increases the wide money supply by increasing V, the velocity of circulation. By not increasing the BoE interest rate we’ve just increased the inflation we’re trying to stop by increasing interest rates.

If we wanted to curb inflation we’d want to raise the BoE rate on reserves above market rates. Which is silly, obviously, which is why we’ll reverse QE instead.

It’s great when the Great Accountant gets the credit and debit the wrong away around, isn’t it? Did someone move the desk from the window?

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