NIESR Review: 'Interest Rate Normalisation'

2 Aug 2017 01:58 PM

In the Commentary of the August 2017 National Institute Economic Review no 241, to be published on 2 August, NIESR Director Jagjit Chadha outlines why it has proved so difficult to get away from “the low interest rate trap” following the financial crisis and suggests it is time to start thinking about returning to ‘normal’ times.

Prof Chadha wrote: “A decade after any increase in Bank Rate, despite continuing concerns about the risks associated with raising rates prematurely, there are a number of arguments for the process of normalisation to begin and in the UK and World Sections of this edition of the Review we have started to outline these scenarios.”

He observed that: “The August 2016 cut to 0.25 per cent was a reaction to an extreme set of circumstances and was not the originally chosen minimum for Bank Rate; withdrawing that stimulus would allow us to signal that the immediate consequences of financial market dislocation following the referendum vote have dissipated. Any increase in rates would still leave Bank Rate far below historic levels and so be more a case of withdrawing extraordinary levels of policy stimulus rather than moving to tight monetary policy.”

Prof Chadha added: “It seems likely that raising Bank Rate will also help the financial sector repair its balance sheet by helping the deposit base and allow lending margins to be restored. As we will be showing in the Review, we think that an impaired financial sector may be a root cause of the disappointing supply-side performance since 2008. But more importantly, it may be time to signal a return to normality and that may be a key to unlocking private sector confidence.”

He concluded: “There are two simple reforms that might help normalisation. First the MPC may also wish to complete its forward guidance by providing projections of Bank Rate and the holdings of assets by the Asset Purchase Facility over the policy horizon. These projections might be given by each member individually, as the Federal Open Markets Committee tends to do, and would allow market participants to form a clearer view on the likely path of any normalisation. Secondly, given the extraordinary circumstances, the MPC may wish to consider smaller or baby steps in the normalisation process.”

Read full commentary here.

Notes for editors:

This press release is based on an article entitled “Interest Rate Normalisation” written by Prof. Jagjit Chadha, published in the National Institute Economic Review No. 241 August 2017.

This journal is a quarterly, peer reviewed, economic and social sciences journal. The full Review is published from midnight on Wednesday 2 August.

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