Monday, January 17, 2011

The Item Club and Interest Rates

As I mentioned in the lecture this morning, the Item Club of Ernst and Young provide an alternative take on the economy from the Monetary Policy Committee of the Bank of England (the committee that decides what interest rates should be - this is monetary policy, which we will consider later in term).

As described by the BBC, the Item Club thinks interest rates should remain at 0.5%, where they currently are. Monetary policy is one of the tools a government has through which to manipulate economic activity; the other main tool is fiscal policy: Government spending and taxation.

Given that the Coalition government is planning to cut government spending and has already begun raising taxes via the VAT rise, economists describe fiscal policy as tight. This means that, as we will note this term in lectures, fiscal policy will restrain economic activity by contributing to a decrease in aggregate demand.

Given this, the Item Club argue that monetary policy cannot similarly be tight. A tight monetary policy would be a policy stance aimed at achieving a fall in aggregate demand. If both policies were tight, then the decrease in aggregate demand would be even stronger resulting in much slower economic growth, and potentially another recession.

Hence the Item Club rightly, in my opinion, argues that monetary policy must remain loose, and hence interest rates should remain low.

However, inflation is above the target the Bank of England is set, and hence this is why some have argued that interest rates should rise. When we get to monetary policy later in term we will get to discuss what impact interest rates have, and hence what the role of monetary policy is.

No comments:

Post a Comment