In the paragraph 39 of the minutes of the last monetary policy committee of the Bank of England there is a very surprising sentence. Everyone has been very attentive to this sentence but it is dramatic.
Before that, in paragraph 37, there was an interesting discussion on the impact of higher interest rates on economic activity, on wages and on the increased burden of the household debt (Households’ debt is 140 % of disposable income and usually at variable rate; that’s why a hike in interest rate could have important effects). The BoE said in paragraph 38 that it will raise interest rates but not now.
Then arrived paragraph 39.
Two members of the committee, Ian McCafferty and Martin Weale, have proposed the following sequence: the labor market is improving but real wages are declining. For them there are lags between the labor market improvement and higher real wages. But they added there are lags between higher wages, change in monetary policy (higher rates) and the impact of this change. The conclusion of their logical sequence is to increase interest rates to improve the efficacy of monetary policy.
“Since monetary policy, too, could be expected to operate only with a lag, it was
desirable to anticipate labour market pressures by raising Bank Rate in advance of them.”
The British economy is just out of its longest recession as GDP has just converge to its pre-crisis level during the second quarter of 2014. But GDP per capita is still far from this pre-crisis level (5% below), productivity is declining and real wages are trending down since 2010. I am not sure that this picture reflects a balanced growth path.
The question is to know the advantages of constraining now the economy since it is not yet on a stable trajectory? With still large imbalances the risk is to go back in a weaker momentum.
It is very surprising and worrying because for many months now economists try to understand the decrease in productivity and in real wages. There are no clear answers on this dysfunctioning of the economy. But these two committee members expect that higher interest rates will be able to solve this equation. That’s worrisome as it reminds the way austerity policies were put in place in the Euro Area or the way the ECB has increased its interest rates in April and July 2011.
The three charts below present a measure of three imbalances that characterized the British economy and which are signals that there is no hurry to increase rates.
The longest recession
GDP per capita is well below its pre-crisis level (for information, the GDP level in the USA is 102.2 in the second quarter 2014)
Lower real wage since 2010