Why an 8% interest rate hike can’t happen in the current global climate

27th August 2010

Hold the front page…. Eminent economic advisor says bank lending rates need to hit 8% in 2012 because a double-dip recession is coming. And hey, who knows, maybe it'll even turn out to be a treble-dipper?

Andrew Lilico, the chief economist at a think-tank called Policy Exchange, has just published a report, reported here in The Daily Telegraph, that says we're not out of the economic woods yet. Specifically, he claims that this year's economic recovery will have run into the sand by the end of the year, and that a brief double-dip recession is coming next year, which may then lead on into a boom by the time that 2012 gets started.

And that, says Mr Lilico, is when the real trouble will start, because an inflationary spiral will kick in.

Thanks to the government's £200 billion "quantitative easing programme" (which was actually a plan to print £200 billion of paper money to cover the bank bail-out), there's going to be a flood of new cash hitting the tills, which will mean that consumer prices are likely to rise by 10% or more in 2012.

To control this sudden inflationary surge, says Lilico, interest rates will need to rise rapidly as well. "To keep [RPI] inflation down to only 10% for one year, the economy will have to be able to tolerate interest rates of perhaps 8%."

A raft of uncertainty

Mr Lilico is understating things a bit when he says that this would represent "an interest rate situation that hasn't been seen since the 1990s". Actually you'd have to go back to the 1970s to find anything half as devastating.

It would bankrupt five million mortgage holders, for a start, and it would bring the retail business to a crashing halt. But is he just courting professional notoriety for its own sake?

After all, as the old joke goes, economists have successfully forecast eleven of the last two recessions. And, as somebody else added, there's never really been such a thing as bad publicity….

It would be unkind and ignoble of us to suggest anything of the kind. Policy Exchange's knowledge of mathematical modelling is probably better than most of us will ever have, and its models have produced a clear prognosis.

If you follow its economic logic all the way, we are indeed headed into deep trouble. But that's the question. Do you really agree that its assumptions are sound?

Well, that's a pretty good question. Ask three economists for a view, and you'll always get four opinions.

There are those who say that national economic considerations will always trump the logic of the market in the long term, and that the government would have plenty of scope to avoid sky-rocketing interest rates if they threatened the recovery.

There are others who say that you can't ever beat the market, and that the threatened crisis is bearing down on us like the four horsemen of the apocalypse.

What we will say, here and now, is that Mr Lilico has as much chance as anyone else of being right.

But also that we are all in uncharted territory, and that, no matter which position you adopt, you can probably assemble a macro-economic argument to support your case.

The monetarists, the Keynesians, the neo-libertarians and the people who simply blame everything personally on Gordon Brown are all at each other's throats out there on the discussion forums, like this discussion on the Citywire boards with no sign of reaching any constructive synthesis. It's a real mess out there, and it's going to get worse.

The FT's blog entry got a surprisingly short (and blunt) response from its two responding

1 thought on “Why an 8% interest rate hike can’t happen in the current global climate”

  1. Jason Aris says:

    This is getting rediculous, I am beginning to think that the whole charade is buying time for the people in the know (i.e rich Greeks and the ‘elite’) and the European Banks to get rid of their Greek Government debt or get their cash out of the country.

    Once the debt is offloaded onto the ECB and the cash safely stashed in Switzerland/Leichenstein the plug will be pulled.

    Just us little people to carry the can then

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