Carney’s Choice

By Simon Bartram

Setting interest rates is no easy task. It would be wishful thinking to imagine that every economic effect of every economic action can be perfectly predicted. We’re dealing with a multitude of different people with different circumstances, personalities and ambitions – evidently not a subject matter that can be easily tested under a microscope and certainly not a topic about which claims can be made with a scientist’s precision. Not to mention that we’re dealing with a new scenario, namely, historic low rates of 0.5 per cent for over six years. Interest rates are set to rise within this year or the next, but the decision of “when”, precisely, the monetary policy committee ought to pull the lever is a hotly debated subject among economists. However, whilst the economic analysis can regularly swing both ways, there should be no doubt that it will be the younger generation that will feel the pain in the next few years as interest rates begin to rise.

So what are the uncertainties?

We can take a fairly topical example. The effect of persisting low interest rates has been said to have fostered the growth of zombie companies – companies which have survived on low loan repayments. The Adam Smith Institute published a paper (link: http://www.adamsmith.org/sites/default/files/research/files/ASITradingDead.pdf) last year indicating that as many as 200,000 businesses were struggling to pay their debts. Many talented workers are currently tied up in these unproductive businesses – these are talented workers who could be employed in more profitable organisations, promoting growth. Alternatively, per the Keynesian argument, when the rates rise the tidal wave will wash them onto the shores of the unemployed, which means less earnings, meaning less aggregate demand in the economy, and potentially leading to less growth. There would be no guarantee that these people would find work instead of boosting the unemployment statistics. The economic analysis swings both ways – depending on your assumptions a rise in interest rates could either help or harm the economy.

Again, a typical Paul Krugman-esque argument would be that low interest rates might encourage greater inflation, which would reduce the real value of the debt of these struggling businesses, helping them to survive, employ people, and contribute to economic growth. Alternatively, it could be argued that these workers are still allowed to be tied up in businesses whose only survival relies on interest rates set artificially low, and when unsustainable inflation hits the economy then the country, not just these workers, are in real trouble, investment decreases and businesses lose confidence. It is modest, and, more to the point, accurate to simply acknowledge that there is no decisive argument or piece of economic analysis to which we can claim to be consensually agreed. As the Austrian economist Hayek noted in much of his writings, there often is no right way to infallibly predict and control human behaviour in complex economies. That’s why forecasts are constantly revised.

The effect of a rates rise on the property market is just as uncertain. Would higher interest rates reduce demand for mortgages as more people find them too expensive? Would they force people out of their homes as they cannot meet their mortgage obligations? Both of which would force down property prices, and would deter cash-buyers from investing in property, thus stopping the housing bubble in its tracks. Maybe. But much depends on the real source of property price rises in, say, London, which were increasing even during times of high interest rates before the crash.

However, inevitably one fact will remain the same. It will still be the richest who can afford property – borrowers who buy to let will pass rate rises onto their, generally poorer, tenants (and thus, paradoxically, make buying property for these folk just as attractive as before a rates-rise); and yet lower earners will find that whilst they can, perhaps, finally reach that elusive ten per cent deposit threshold if property prices do decline, their income won’t sufficiently appease mortgage-lenders offering higher commercial interest rates. So, regardless of the predicted effect on property prices, the decision of when to raise interest rates will have little effect on people within different income brackets – it will still be beneficial to have higher reserves and higher earnings, as putting down a higher deposit will cushion the effect of rates rises and higher earnings ensures that monthly expenditure is sustainable. That will remain unchanged

Ultimately, therefore, Carney’s choice cannot be easily framed within the paradigm of the classic struggle of the least wealthy against the most wealthy, but it will instead be remembered as part of a generational struggle. The pattern of saving and borrowing is often, though not always, fairly standard during different people’s lifetimes. Generally, the older generation save for retirement as they comfortably meet, or have already paid, their mortgage obligations, whilst the relatively younger part of the population borrow to establish themselves and support their families.

The generation that benefited from completely state-subsidised university education, final salary pensions and tax relief on interest payments have bemoaned the five year low-interest rate freeze brought about by the financial catastrophe in 2007. They’ve grumbled so much, in fact, that the Save Our Savers (link: http://www.saveoursavers.co.uk/) pressure group managed to push George Osborne into delivering a “budget for savers” packed with sparkling new supersized tax-free ISAs and a series of pension reforms. So too will young families making substantial mortgage payments, or young entrepreneurs backed by bank loans, or young professionals getting their foot on the property ladder, begrudge a rates rise (though, I would suggest, much less vocally than Save Our Savers and their ilk did over the past five years). This conflict is inevitable, for the age of record low interest rates and cheap credit will not, cannot, and should not survive forever for fear of complacent businesses surviving only on low interest rates and the risk of future inflation (which, so far, has not materialised). However, it is nonetheless part of a larger conflict which seems to keep resurfacing in the narrative of current economic news stories.

The key charge is that the generation that inherited so many postwar state benefits has now bequeathed to the younger generation a crash, higher debt, and a property market crawling with predatory investors.  Carney’s choice, albeit inevitable, will only add fuel to that fire.

Simon Bartram is a freelance writer, having graduated with a first-class degree in Modern History and Philosophy from the University of St Andrews. He works full-time in the City of London and is a student of the Institute of Chartered Accountants in England and Wales.