Letter to the FT: The MPC knows what it’s doing

Sir, There are some mistakes in Sir Michael Darrington’s letter urging for interest rates to be raised.

Sir Michael writes that the MPC “has only one objective”: to keep inflation under 2 per cent. In fact, the Bank of England Act 1998 states “the objectives of the Bank of England shall be a) to maintain price stability, and b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.”

Secondly, Sir Michael argues that higher rates would encourage savers to spend by increasing their interest income and increase tax revenues on interest income. That may well be the case, but as Frédéric Bastiat pointed out 160 years ago, it is important to take account of all the consequences of a policy intervention, not just the obvious ones.

Tax revenues on interest would indeed increase, but by the same token corporation tax receipts would fall as companies’ taxable profits were squeezed by higher interest charges. As a “prudent saver” myself I share the frustration of many that the interest we earn is lower than the current rate of inflation, but few savers live off their interest income so it is unlikely that increasing it would have a significant impact on demand.

It would be foolish of the Bank to risk killing the nascent recovery with an early interest rate rise. As the example of Japan shows, while inflation has winners and losers, deflation in an indebted economy has only losers.

P.S. for blog readers: Martin Wolf wrote an excellent article arguing against a rate increase in Friday’s FT.

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