Following in Newton's footsteps
Updated on 08 January 2009
Our economics correspondent Faisal Islam blogs on why today's historic interest rate cut raises more questions than it answers.
It is an historic decision which takes interest rates in the UK to their lowest since the Bank of England was created, around the time when Isaac Newton discovered gravity.
At the same time this decision is also almost completely irrelevant to kickstarting the economy.
Banks that aren't lending will not now suddenly start lending because the Bank of England base rates have been cut by half a per cent.
Of course those living off savings income will suffer again. But savings in the economy and any attempt to kickstart consumer spending will be more driven by fears over job security than the rates of interest available.
The importance of today's move is in its symbolism. British economic policy is now a giant experiment. We have never had interest rates so low. Tax and spending policy is a fiscal test tube.
The importance of today's move is in its symbolism. British economic policy is now a giant experiment.
But really all eyes are now on the likely experiment with "non-traditional" forms of monetary policy that is yet to come, should interest rates hit zero per cent.
Monetary policy could never be deemed kinky, but there's some pretty wild stuff emerging around the world to kickstart those economies crippled by the credit crunch.
The US Federal Reserve has already announced its readiness to buy up bonds issued by state-backed mortgage companies and even US Treasury debt - so called Japanese-style "quantitative easing".
The aim is to create money and drive down long-term interest rates, rather than lowering the price of short-term credit, which is what the Bank of England did today.
Whatever is communicated publicly "Mervyn-san" and the chancellor are actively planning for what they consider to be a contingency.
But this would have to involve a revolution in 11 years of Bank of England independence to set monetary policy. What would the point be of the nine-member Monetary Policy Committee repeatedly voting to keep short-term base rates at zero?
Could the MPC vote on long-term interest rates, or vote to buy up various types of corporate or mortgage debt?
As Britain appears to be rediscovering economic gravity, let's hope that the giant experiment being carried out on our economy is as much of a success.
Realistically, these types of interventions would at least require co-ordination with the debt management office. They could well be rather firmly in the orbit of treasury rather than Bank of England decision-making. There are other details.
The Bank would be encouraged to communicate in advance that rates might stay around zero for months, which is a complete no-no under current arrangements. It all raises a rather obvious question: who will be in charge?
The institutional structure that has governed our economy for the past 11 years appears unable to cope with a rather likely world of zero interest rates.
Isaac Newton was himself a rather successful experimenter. As Britain appears to be rediscovering economic gravity, let's hope that the giant experiment being carried out on our economy is as much of a success.
