Joe Storey is an A-Level student who is researching Margaret Thatcher’s influence on the current Conservative party’s economic policies.
With the Coalition government securing Britain’s economic recovery and the growth forecasts for 2015 and 2016 being upgraded by the International Monetary Fund (IMF) (to 2.2 per cent and 2.6 per cent respectively), loose monetary policy has had its time. The dark side of these policies is coming to fruition, with household debt levels reaching record highs. According to a report by the Centre for Social Justice, the average indebtedness of British households has nearly doubled to £54,000, compared to £29,000 a decade ago. In 2012, an estimated 1.7 million sought free professional debt advice to resolve their problem debt, highlighting the growing problem of household debt. Moreover, the Money Advice Service has estimated that close to 9 million Brits are “over-indebted”, with half of that figure on incomes of less than £20,000. If interest rates remain this low, the quandaries associated with cheap credit will be compounded and will continue to occur. Until the base rate is increased to a more sustainable level, Britain will not be weaned off cheap credit.
Record levels of household debt is only one of the unintended consequences of low interest rates. Savers have been plagued by years of negative real interest rates which have disincentivised the act of saving. Data analyst Moneyfacts has predicted that even basic-rate taxpayers need an account paying 2.38 per cent interest to offset the effect of inflation on their savings. Further research suggests that of the 837 easy-access savings accounts on the market, only 57 offered interest high enough to protect their savings from inflation. And the predicament savers are facing is worsening, despite inflation steadily falling.
When the base interest rate of 0.5 per cent was first implemented in 2009, the interest on the best easy-access accounts remained around 3 per cent. Now, however, the best buy rate on easy-access saving accounts is around 1.5 per cent, exacerbating the pain the average saver feels. The effect on savers has been highlighted in America, which is also experiencing unsustainably low interest rates. Since the US has had a base rate of 0.25 per cent, the number of taxpayers has increased by 13 million yet those reporting any taxable interest fell from 67.2 million to 57.8 million. Furthermore, the proportion of American taxpayers reporting any interest from saving at all plunged from 53 per cent to 44 per cent.
Loose monetary policy also reduces the competitiveness of domestic firms as some survive solely on cheaper credit. Had the cost of borrowing increased, these so-called ‘zombie firms’ would have had to either make structural reforms or exit the market. There is now a situation where zombie firms account for 1 in 10 of British businesses and they all have one similar characteristic: they can service their debts due to low interest rates, but there is minimal chance that they will eliminate the burden of these debts. Whilst rates remain so low, uncompetitive ‘zombie’ firms are protected as they do not need to make the necessary structural reforms in order to remain competitive within the market.
It would be more appropriate for the Monetary Policy Committee (MPC) to commence an interest rate rise now in steady increments, rather than leave the rise too late and be forced to suddenly increase the base rate. In terms of the housing market, prices are exceeding pre-recession levels and only look like they will increase further, particularly with the expansion of Help to Buy to 2020. Increases of the base rate in steady increments will highlight to consumers the true cost of borrowing, rather than low interest rates providing the illusion of affordability.
Osborne has warned of the ‘difficult decisions’ to come and the Bank of England’s decision to increase interest rates will undoubtedly be one of them. The Office for Budget Responsibility (OBR) and Treasury forecasters have predicted significant financial pain for consumers if there is an increase in the base rate. The OBR has forecasted that three million mortgage holders (24 per cent of the total mortgage holders) would be forced to either work more, cut spending or re-mortgage if interest rates were increased by a mere 2.5 per cent (a 500 per cent increase on the current rate, but mere in terms of a more orthodox base rate level). With these figures in mind, it is obvious why the Bank of England is keen to increase rates after the 2015 election due to the substantial electoral impact it could have.
Whilst these lower rates were appropriate in the short-run to stimulate economic growth, they cannot be allowed to continue. Currently there is a situation whereby there is protection for those who overindulge on cheap credit at the expense of prudent savers. The Government has also contributed to the damage caused by low interest rates and QE. It seems bizarre that George Osborne is endorsing 95 per cent mortgage guarantees given that in 2006 he wanted to see the end of “credit card Britain”. Help to Buy seems even more baffling as mortgage rates are at the lowest in modern history and can only increase from here on in.
Britain’s monetary policy requires a return to orthodoxy in order to stem the ‘debt-bomb’ which is accumulating. With Britain’s national debt at close to 1.3 trillion (the equivalent of £37000 for every taxpayer) and household debt soaring, a return to higher rates is imperative for fiscal prudence and for Britain to live within its means.
 Insolvency Service, Statistics release: Insolvencies in the second quarter 2013, London: ONS, 2013 [accessed via: http://www.insolvencydirect.bis.gov.uk/otherinformation/statistics/201308/index.htm (28/08/13)];
Money Advice Trust, Demand capacity and need for debt advice in the United Kingdom – 2012, Nottingham: Money Advice Trust, 2012 [accessed via: http://www.infohub.moneyadvicetrust.org/resource.asp?cat_id=260&rPath=cat&r_id=770 (14/10/13)]