Does the BoE serve only one section of society?
- 9 July 2012
The Bank of England was originally formed by a group of bankers who would balance the sum of their transfers between each other's banks at the end of the trading day to reduce the number of transactions that would occur (only one payment of the total amount owed from each bank would be paid to the corresponding bank, reducing the administrative activity, to save time and money). This took place at Lombard Street in London and was the principle function of what became the central banking system. Each bank has a reserve account at the Bank of England, which is used to hold funds to pay and receive transfers from other banks and it still remains the primary function of the central bank.
Over time the Bank of England would lend money to banks who had encountered financial problems to prevent bank runs and bank failures. It became a security mechanism and lender of last resort that could intervene to resolve short term abnormalities in the banking system preventing financial crises. This became the secondary function of the central bank to oversee the stability and general functioning of the banking system and to intervene with potential bank collapses. The Bank of England has been performing these two functions for over a century to a greater or lesser degree. In the 1980s the Bank of England and central banks throughout the world took on a new function through the monetarist movement.
The monetarists believed the rate of inflation should be controlled and that the mechanism to implement this control should be the interest rate. The Bank of England set a two percent target for the rate of inflation and the interest rate would be reviewed on a monthly basis by the Monetary Policy Committee (MPC) to attempt to hit the inflation target. This was seen as a successful strategy for almost 30 years, until the recent financial and economic turmoil which has seen a rise in criticism of the existing banking system. The level of private and public sector debt has risen over the last decade and a half to record levels. The potential involvement of the inflation target in creating this problem has been raised and questioned, in addition to fears that the interest rate itself has become ineffective in its application.
Regardless of the current questions about the level of debt and the usability of the interest rate to hit the inflation target, it is difficult to ignore its past application has come at the expense of one sector of society to the benefit of another. Controlling inflation will reduce the devaluing impact that higher prices have on investments. In short this means the lower rate of inflation will maintain the purchasing power of savings which makes the existing rich richer. The increase in the interest rate to reduce inflation will increase the return on the investments of the rich also making them richer. The use of the interest rate to control inflation reduces wealth devaluation and at the same time maximises return creating a wealth preservation system through the central bank's interest rate decisions.
However the disparity in benefactors is much greater than merely financial investments. Property values and the expansion of debt, which occurred through the lower interest rates seen throughout the last fifteen years, rocketed as a result of the Bank of England's Monetary Policy Committees interest rate decisions. The value of existing homeowners properties increased as a result of the Bank of England's artificial price fixing of the interest rate, making the property owning sector of society and in particular the Baby Boomer generation wealthy for no other reason than buying a house at the right time. Not only did the home owning elite receive a huge boost in their portfolio value but they were allowed cheaper credit and larger amounts of it than everyone else, due to their property acting as collateral. Everything became cheaper for existing homeowners than it was for everyone else, through the Bank of England's intervention and the way credit has been priced.
This came at the expense of the younger generation being priced out of the property market and having to rent. The rents they were charged were based on the property value, which is usually between three to five percent of the current market value of the house. As the housing market has been so high for so long the cost of renting has been, in many cases, higher than the cost of the mortgage. Many people could not get the deposit to buy a house and even if they did they could expect to take a mortgage out at as much as seven to eight times their annual earnings. The few young people who could afford to buy a house have purchased them at a historically unprecedented price, which may decline in value leaving them with negative equity if the Bank of England ceases its artificial stimulus through lower interest rates and Quantitative Easing.
The figures are staggering and actually a lot worse than I had anticipated and it is not just the UK it is everywhere that the monetarist economic movement has been adopted. An example of how difficult it has become to get on to the property ladder is the high number of adults in the EU living with their parents. In 2008 46% of 18 – 34 year olds lived with their parents across the EU economic region. But it is not just housing. The level of debt including credit cards has hit critical levels across the whole of the EU with the UK being the worst country among the EU 27 member states. It was estimated 5% of households had to pay more in monthly debt repayments than the income accounted for in 2008. This figure could only have become greater since the financial crisis, which subsequently followed.
It begs the question as to whether controlling inflation is really worth the wider economic impact it creates. Not only has the housing market become unstable, requiring continual central bank intervention just to keep it buoyant, but the rich poor divide has widened to levels not seen since the Victorian period. I cannot help but think that this was the real intention of the Bank of England's decisions and the objective of monetarism from the outset. It seems that one generation in particular, the Baby Boomer generation who have a large voting lobby due the population boom between 1946 and 1964, have benefited at the expense of everyone else through the central banks decisions. It is almost like a secondary social security system for them, which they seem to benefit from over everyone else. Perhaps it is time for a change?
More on Mindful Money
Sign up to our daily newsletter and you could win an Amazon Kindle Touch.
- The Manchester United and David Moyes saga is all about the debt and leverage
- What has happened to food and energy prices and inflation in 2014?
- Both the Bank of England and the UK Public Finances are having a Mad Hatters Tea Party
- Invesco Perpetual's Mark Barnett on where UK equities go from here
- AstraZeneca gets a Pfizer boost
- Mindful Money's weekly share-tips: Sports Direct, Reed Elsevier, Unilever, William Hill and WPP
- The unanswered question - could new mortgage lending rules restrain house prices - outside London at least?
- Gap between investor income expectations and actual returns widens
- Despite greater pension freedom retirees are set to see their income collapse
- Consumer group Fairer Finance calls on banks and insurers to spare their customers the small print