The monetary dilemma

According to the minutes of the last meeting of the monetary policy committee of the US Federal Reserve Bank, the most powerful monetary authority in the world, the committee members are split and unclear on what to do.  “Some participants who counselled patience expressed “concern about the recent decline in inflation” and said the Fed “could afford to be patient under current circumstances.” They “argued against additional adjustments” until the central bank was sure that inflation was on track. On the other side, more hawkish members “worried about risks arising from a labour market that had already reached full employment and was projected to tighten further…..backing off from a steady diet of rate hikes could cause the Fed to overshoot its employment target and cause financial instability”, they said.

The problem is that the Fed’s economic models were failing to provide guidance on what to do.  The current mainstream model has two strands.  The first is the Wicksellian idea that there is a ‘natural rate of interest’ that brings a capitalist economy into harmonious equilibrium where economic growth and full employment and stable and low inflation are combined.  The Fed calls this R*.  The second is the Keynesian view that there is a trade-off between unemployment and inflation, so that as an economy heads towards ‘full employment’, this drives up ‘effective demand’ beyond any ‘slack’ in supply in the economy and so wages and price inflation ensues.  This is enshrined empirically in the so-called Phillips curve, named after a British economist of the 1960s.

The trouble with this mish-mash of a central bank model is that it is not working.   The trouble with the Wicksellian bit is that it is nonsense – there is no equilibrium rate.  Even worse, the Fed’s economists have no idea what it should be anyway.  The Fed’s central estimates of the real neutral interest rate has declined by nearly two-thirds in five years, from 2 per cent to 0.75 per cent. On that basis, the Fed has already exceeded the ‘natural rate’ and is in danger of causing a downturn in the economy.

But the figures are again little more than guesswork. As Ms Yellen said, “[the neutral rate’s] value at any point in time cannot be estimated or projected with much precision”.

The second half of the model is equally faulty.  The Phillips curve, measuring inflation against growth and full employment, was proven faulty in the 1970s when inflation rocketed but economies had rising unemployment and falling growth – ‘stagflation’. Indeed, the inadequacy of this Keynesian model led to a counter-revolution in mainstream economics, as economists and politicians swung over to monetarist policies like the quantity theory of money proposed by Milton Friedman and adopted by his epigone, former Fed chief Ben Bernanke.

This was eventually taken to its extreme in quantitative easing (QE).  This was the ultimate policy – if an economy is in a depression, it’s because of a lack of money.  So just keep pumping it out until things get better.Well, things have supposedly got better, so QE has been dumped and the old Keynesian Phillips curve has been restored as guidance to the Fed.  Unfortunately, just as in the 1970s, the model is not working.  Unemployment rates are near lows – at least in this current business cycle of 8-10 years – but higher inflation in prices and wages has not returned.

Indeed, it has been a quarter of a century since the Fed’s favoured measure of inflation — personal consumption expenditures excluding food and energy — last punched up above the still relatively sedate level of 3 per cent. It was just 1.4 per cent in the year to July. Wage growth, meanwhile, remains well below its pre-crisis pace at just 2.5 per cent.

Janet Yellen, chair of the US Federal commented: “Our framework for understanding inflation dynamics could be ‘misspecified’ in some fundamental way.” Mario Draghi, president of the European Central Bank, observed, “the ongoing economic expansion . . . has yet to translate sufficiently into stronger inflation dynamics”.  He’s still hoping.  And of course, Ben Bernanke, the monetarist extraordinaire, continues to believe that the Fed’s policy models will work, as he argued in a new paper presented to the Peterson Institute and the IMF this week.

But the evidence is not there.  Monetary policy has failed to ‘manage’ the capitalist economy.  Monetary policy did not avoid the global credit crunch or save capitalist economies from going into the Great Recession – even if non-stop zero interest credit saved the banking system from complete meltdown (and even that conclusion is open to doubt).

And QE did not revive the ‘real’ economy, the productive sectors, afterwards and instead only inspired a humongous new speculative boom in property, stocks and bonds that continues today (boosting the incomes and wealth of the top 1% everywhere).

In this Long Depression, jobs may have appeared in some economies, but only at low wage rates, only temporary, part-time or self-employed.  Real GDP growth has been strangled at no more than 2% a year in the US and even lower in other advanced economies.  Business investment has crawled along and, as a result, productivity growth, essential to a long-term revival in capitalist economies, is sluggish and even non-existent.

So what to do?  The Keynesians, still believing that the Phillips curve model works, conclude that ‘effective demand’ is still too low and the major economies are stuck in ‘secular stagnation’, not seen since the immediate post-war period (an idea developed by Keynesian Alvin Hansen and proved wrong by the revival of economies form 1947 onwards).  In their latest contribution, former IMF chief economist Olivier Blanchard and top Keynesian Larry Summers tell us in another Peterson Institute presentation that what is needed is a combination of monetary easing and fiscal spending:

“What we specifically suggest is the following: The combined use of macro policy tools to reduce risks and react more aggressively to adverse shocks. A more aggressive monetary policy, creating the room needed to handle another large adverse shock—and while we did not develop that theme at length, providing generous liquidity if and when needed. A heavier use of fiscal policy as a stabilization tool, and a more relaxed attitude vis-a-vis debt consolidation. And more active financial regulation, with the realization that no financial regulation or macroprudential policy will eliminate financial risks. It may not sound as extreme as some more dramatic proposals, from helicopter money, to the nationalization of the financial system. But it would represent a major change from the pre-crisis consensus, a change we believe to be essential.”

Actually, what the two gurus advocate is not “a major change”, but really just more of the same that has failed so far to revive the economy.

They had little to say about the Fed’s plan to sell off its huge stock of bonds that it built up under its QE policy of purchases.  The Fed wants to do this because it reckons the economy is sufficiently recovered to cope with a reversal of QE and a tightening of credit.  Well, you could argue that, as QE had little effect on boosting the ‘real’ economy, reversing QE will have little effect in dampening it.

Maybe so, but what also worries the Fed is that a near-decade of easy money Bernanke-style has so boosted levels of debt in the household and corporate sectors that any rise in interest rates and tightening of credit would drive up debt servicing costs and tip the economy into recession.  On the other hand, the Fed does not want to go on pumping yet more credit to make the situation worse.  As Janet Yellen put it: “Persistently easy monetary policy might also eventually lead to increased leverage and other developments, with adverse implications for financial stability.”.

This fear has been promoted by the Bank for International Settlements, the central bankers’ bank, which in true Austrian school of economics style, reckons that increased costs of debt servicing from rising interest rates driven by the Fed’s ‘normalisation’ policy could tip things over.

And the IMF in its latest Global Financial Stability report out this week, is also worried that the very size of global debt could eventually lead to serious defaults and retrenchment that would push the global economy back into recession.

The IMF comments that “a shock to individual credit and financial markets well within historical norms could decompress risk premiums and reverberate worldwide, as explored later in this chapter. This could stall and reverse the normalization of monetary policies and put growth at risk.”  So if the Fed and other central banks now decide to reverse QE and opt for ‘normalisation’ of their balance sheets, this could be damaging. Too quick an adjustment could cause unwanted turbulence in financial markets and international spillovers.”  On the other hand, “the expected process of normalization is likely to be gradual, with continued easy monetary conditions and low volatility that could foster a further buildup of financial excesses and medium-term vulnerabilities.”.  So heads you lose and tails you lose.

The IMF sets the dilemma: “Managing the gradual normalization of monetary policies presents a delicate balancing act. The pace of normalization cannot be too fast or it will remove needed support for sustained recovery and desired increases in core inflation across major economies …On the other hand, the likely prolonged period of low interest rates could further deepen financial stability risks as investors take on more risk in their search for yield.”

The IMF reckons such a debt disaster could hit global growth by up to 1.7% pts a year through 2022 – in effect, cutting current growth by more than half and taking it to levels not seen since the Great Recession.  The ensuing recession would “about one-third as severe as the global financial crisis”.

The Fed’s dilemma reveals that monetary policy has failed.  It failed to save the world economy from the Great Recession and it failed to get it out of the ensuing Long Depression.  Central bank models of the economy, based on a combination of monetarist neo-classical and Keynesian economics, appear to offer no guidance on what stage the major economies are now in and therefore what to do.  Should central banks hold back on hiking rates and reversing QE in case economies are still too weak; or should they act now to avoid a huge debt crisis down the road?  They don’t know.

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18 Responses to “The monetary dilemma”

  1. davidwalters66 Says:

    Michael, slightly off topic…but have you been following the “de-dollarization” of the US dollar by China? USA today had a recent report on this. It could have profound effect on the value of the USD. The Chinese and Saudis, for example, have agreed to exchange oil for yuan. Your thoughts?

    • michael roberts Says:

      It’s early days but the Chinese are trying to turn their currency into an international one to rival the dollar. They cannot replace the the dollar as the international reserve currency yet and there are real risk for the Chinese economy if the yuan becomes fully convertible internationally and speculated in. Nevertheless, it is sign of the future. The Saudis are doing this because they will get a better price (in dollars) if the yuan appreciates and also to snub the Americans for their failure to get rid of Assad and Iran.

    • Cameron Says:

      According to the Wall Street journal “The Chinese government announced plans Wednesday to raise $2 billion from international debt markets”. This is the first dollar denominated bond sale since 2004. How does that fit into the “de-dollarization” meme?
      The $2 billion is a drop in a bucket compared to over $1 trillion of its holding of the US treasuries. So it’s not like it need dollars.

      • michael roberts Says:

        It’s cheap to borrow in dollars and although China has trillions in FX dollar reserves, it can use this to fund its beltway projects internationally without reducing reserves.

    • sartesian Says:

      Have to agree with Michael. Haven’t we been through this/heard all of this before– about the euro for example, or the yen? Wasn’t there even the theory that Bush invaded Iraq because Hussein was changing the medium of exchange for oil from dollars to euros, the better to avoid US sanctions?

      Misses the point, or missed the point IMO– which was the previous recession, the decline in 2002 of oil prices to $20/barrel and the consequent cratering of profitability.

      The Chinese Communist Party leadership has a real problem– that is to say making the yuan an international reserve currency has to be preceded by making it freely convertible in the world currency markets, and thus exposes it to the risk of revaluation in those same markets. We, and the CCP leadership saw, in the 1996-1998 period what that meant to the Thai, South Korean, Taiwanese, Indonesian capitalists– and in contrast, what the Malaysian state had to do to protect its capitalists. IMO the CCP leadership is torn between the prospects and the risks of letting the yuan “freely” float in the world currency markets.

    • kiers Says:

      very early days. a lot of what comes out about China in the US press is to create strategic “balance” with the old US bugbear, Russia. The reality is something else. There is *a lot* of “elevation”/”blowing sunshine” re China in US press at all times. Right now China is uncomfortable with an open capital account. End of story. Caveat Lector.

  2. Cameron Says:

    “The Fed wants to do this because it reckons the economy is sufficiently recovered to cope with a reversal of QE and a tightening of credit.”
    The Fed’s mandate is really “wealth effect” which is the code word for making the capitalist class wealthier at the expense of the rest. It’s another version of the “trickle down” nonsense. The Fed’s mandates are not inflation and employment. It will raise the rate in December. Low inflation, no problem. What the Fed is really worried about is financial instability. The so called ultra loose Monetary police has resulted in an incredible explosion of public and private debt as well as bubbles in financial and property markets. This is very worrisome. The Fed realizes it’s getting out of control and could lead to financial instability.
    I don’t believe the issue is the Philips curve or Keynesian theories, etc. The yield curve has been flattening and could soon become inverted signaling recession. So in a nutshell, the Fed’s mandate at this point is to raise interest rates and unwind QE to bring the financial and property markets under control and at the same time provide ammunition for the upcoming recession.

  3. Boffy Says:

    The official interest rates of the central banks have little relation to the actual market rates of interest, as Marx sets out in Capital III, where he says if you want to compare the latter between say Britain and india, look not at government bond yields, but at the rates of interest that business charge to loan equipment to each other etc.

    With the fed having been raising rates and tapering QE for more than a year, credit conditions in the US have actually loosened rather than tightened. The economy has grown more during the period. The QE and low official interest rates were designed not to stimulate growth, but to protect the paper wealth of the private capitalists, by reflating the prices of property and financial assets.

    Whatever they might say, the real reason Fed members are divided is not about whether further rate rises will hit the real economy, but whether they will hit asset prices, as happened in 2000 and 2007, when they started to raise them. The trouble is that with yields on many of these assets already at historically low levels, if they faced another 2008, the amount of liquidity they would have to pump in to push up those asset prices would be even more astronomical. They are trying to ride between the fact that the economy has continued to grow, and create jobs despite their efforts to divert money-capital into financial assets and property, and now threatens to get away from them sending inflation and market rates of interest higher, and thereby crushing the asset prices, and the fact that if they raise rates and try to slow the economy, that in itself will crash the asset prices.

    Its a dilemma entirely of their own making over the last thirty years of the greenspan Put.

    • sartesian Says:

      The official interest rates of the central banks have little relation to the actual market rates of interest, as Marx sets out in Capital III, where he says if you want to compare the latter between say Britain and india, look not at government bond yields, but at the rates of interest that business charge to loan equipment to each other etc.”

      Of course the above is just wrong as the last 40 years amply demonstrate where actual market rates of interest are closely tied to central bank rates of interest.

      “With the fed having been raising rates and tapering QE for more than a year, credit conditions in the US have actually loosened rather than tightened. The economy has grown more during the period.”

      That’s because interest rates do not determine “credit conditions.” Rather credit conditions are manifestations of the general economic status of capital– i.e. how well or not profit is aggrandized.

      “QE and low official interest rates were designed not to stimulate growth, but to protect the paper wealth of the private capitalists, by reflating the prices of property and financial assets”..

      the point is that the bourgeoisie don’t distinguish between the two “growth” “economic recovery” and “paper wealth.”

      Did the Fed specifically set out to reflate real estate prices? — of course not. The Fed acted to preserve capitalism; to offset the freeze in the capital markets brought about by the mass of non-performing securities and debt instruments. And…the Fed didn’t act alone; it acted in concert with FDIC and the US Treasury to create programs for “orderly” (if such a term can be used) devaluation of non-performing assets. Over time, the mass of non-performing loans in the US has been reduced;– not so in Europe where banks did not realize the losses and still carry these NPLs on their backs– to the tune of approximately a trillion euros.

      And this: “Whatever they might say, the real reason Fed members are divided is not about whether further rate rises will hit the real economy, but whether they will hit asset prices, as happened in 2000 and 2007, when they started to raise them. The trouble is that with yields on many of these assets already at historically low levels, if they faced another 2008, the amount of liquidity they would have to pump in to push up those asset prices would be even more astronomical. They are trying to ride between the fact that the economy has continued to grow, and create jobs despite their efforts to divert money-capital into financial assets and property, and now threatens to get away from them sending inflation and market rates of interest higher, and thereby crushing the asset prices, and the fact that if they raise rates and try to slow the economy, that in itself will crash the asset prices.”

      ..is just complete and utter nonsense. The “real economy” is not “threatening to get away;” is not threatening to send inflation and market rates higher and “crushing asset prices,” when in fact asset prices appreciate under periods of increasing inflation.

      This “dilemma” is not now, nor has it ever been a dilemma of the Fed’s” own making.” It is now, as it always has been, created by the conflicts and antagonisms inherent in the accumulation of capital— namely overproduction and the tendency of the rate of profit to decline.

      • Henry Says:

        Some often ask what Marx would do or say if he were alive today.

        I would say he would have filed a lawsuit against Boffy for defamation.

      • jlowrie Says:

        ”Some often ask what Marx would do or say if he were alive today.

        I would say he would have filed a lawsuit against Boffy for defamation.”

        How depressing that a socialist should insinuate that Marx, the most profound critic of capitalist property relations, would so demean himself as to have recourse to bourgeois litigation in order to resolve a contested issue in a scientific controversy.

      • Boffy Says:

        J,

        The point is they are not socialists. They are just trolls and their sock puppets who know nothing, and whose only purpose in life is to try to provoke flame wars. Its why I don’t even bother to read what they say. The scroll button on the mouse is extremely useful.

      • sartesian Says:

        “How depressing that a socialist should insinuate that Marx, the most profound critic of capitalist property relations, would so demean himself as to have recourse to bourgeois litigation in order to resolve a contested issue in a scientific controversy.”

        Irony, comrade J, I believe you missed the irony in Henry’s comment.

      • jlowrie Says:

        ‘Irony, comrade J, I believe you missed the irony in Henry’s comment.”

        I do ”confess” that Henry’s irony was so subtle that I missed it. Certainly irony has a role to play even in scientific discourse. I just hope that Henry with his propensity for bringing matters before a court has no aspirations to becoming a latter-day Vyshinsky!

      • Henry Says:

        Lowrie, yes not everyone gets irony!

        For the record and for those who needs things spelling out explicitly and who live in a world free of irony, I don’t think Marx would bother himself at all with Boffy, whose main points seem to be that what is good for capital is good for labour.

        Maybe instead of taking Boffy to court he would pay someone to beat him up? Personally I really couldn’t give a shit what Marx would do if he were alive today. It’s a rather mute point.

        Oh but I brought that up I hear you cry, I cry back at you IRONY!

      • Henry Says:

        Another thing, please do not mistake Boffy’s mutterings as science, I mean seriously? You think that is scientific discourse! Jesus!

      • jlowrie Says:

        Thanks for these insightful comments, Henry. No irony intended!

  4. Boffy Says:

    The dilemma facing central banks is highlighted by the fact that UK CPI has risen to 3%. A year or so ago the concern was over the potential for disinflation or even deflation. The rise to 3%, which looks likely to rise further, in the next few months, has been driven by the fall in the value of the Pound, which has arisen due to the Brexit vote. The Bank of England now looks set, next month, to double its official interest rate from 0.25% to 0.50%. Yet, the effect of that is likely to be perverse compared to what orthodox economic theory would suggest.

    The likely effect of the Bank of England raising its official interest rates is that speculators will begin to feel less certain that the bank has their back. As yields on government bonds have fallen to near, and even below zero, as asset prices have been pushed up by speculation, the incentive for speculators to buy or hold them has increasingly turned to an attempt to make capital gains, or at least to avoid capital losses, rather than to obtain yield. The yields on nearly all European 2- 5 year bonds, for example, are currently negative, whilst the UK 2 Year Gilt currently yields just 0.40%. If speculators begin to feel that they cannot even rely on central banks to have their back to prevent bond prices falling, so that they suffer these capital losses, the remaining motivation for buying or holding bonds disappears, apart from where institutions are bound to hold a portion of their portfolio in such assets.

    As Marx said,

    “If an untowardly large section of capitalists were to convert their capital into money-capital, the result would be a frightful depreciation of money-capital and a frightful fall in the rate of interest; many would at once face the impossibility of living on their interest, and would hence be compelled to reconvert into industrial capitalists.” (Capital III, Chapter 23, p 378)

    And, indeed such a frightful depreciation of money-capital is what we have seen, as any amount of it, now buys significantly less of these financial assets and property than it did ten, twenty or thirty years ago. That is also why pension funds have developed such huge black holes, because workers monthly pension contributions have bought progressively fewer and fewer bonds and shares over the last thirty years, as the prices of bonds and shares have been massively inflated. The underlying capital base of the pension funds has thereby been systematically undermined, and undermined to an even greater extent as in order to make up for falling yields, the funds have utilised paper capital gains, to pay out pension liabilities, thereby turning them into nothing more than Ponzi Schemes.

    As Michael pointed out a while ago,

    “as of August 2013, loans outstanding to UK residents from banks were £2.4tn (160% of GDP). Of this, 34% went to financial institutions, 42.7% went to households, secured on dwellings, and another 10.1% went to real estate and construction. Manufacturing received just 1.4% of the total! UK banking’s principal activity is just leveraging up existing property assets. I identified the same point in work done for the pamphlet for the Fire Brigades Union on the need for public ownership of the banks and found that the big five banks in the UK hold £6trn in assets. This is equivalent to the amount that more than 60 million British people produce in four years. Yet the banks have earmarked just £200bn of this to investment in industry in the UK, a measly 3% of the total.”

    And, the consequence of this is also illustrated in another piece of analysis done by the BBC and the Open Data Institute, which shows that the majority of UK house prices are lower today than they were ten years ago, whilst the extent of speculation in London, the South-East and east of the country has created a grossly distorted housing market.

    On the one hand, we have all of this liquidity driven into property speculation, just as we have had liquidity driven from QE, the LTRO’s of the ECB etc. driven into the purchase of government bonds, and at the same time, we have this dearth of lending available for small and medium sized businesses, who are led towards borrowing on credit cards (20-30% p.a), or via peer to peer lending (around 10% p.a.), as well as households led into increasing credit card and other high-cost debt, as well as all of that debt increasingly driven into the arms of the payday lenders charging rates up to 4000% p.a.

    It is an example, of the point made by Marx that in examining the actual market rates of interest, it is not government bond yields, or the official Bank of England rates that are relevant, but the rates that firms themselves have to pay to borrow for productive purposes.

    “For instance, if we wish to compare the English interest rate with the Indian, we should not take the interest rate of the Bank of England, but rather, e.g., that charged by lenders of small machinery to small producers in domestic industry.” (Capital III, Chapter 36, p 597)

    If speculators begin to feel that the Bank of England no longer has their back, as it doubles its official interest rate from 0.25% to 0.50%, then they may start to shift their money into the financial assets of other countries, for example, German Bunds, where the ECB is still busy buying up those assets, and putting a floor underneath them. The consequence then would be a flight of that hot money out of the UK, causing the value of the Pound to fall, whereas orthodox economic theory would suggest it should cause it to rise. That is what has been seen in recent months, elsewhere. The US Federal Reserve started raising its official interest rates, and ended QE, and the Dollar rather than rising has fallen in value. The ECB, which by contrast embarked on its own QE programme, has seen its support for Eurozone sovereign bonds lead to additional funds come in to follow through on a one way bet, to push up their prices and push down their yields, so that even Greek 2 year Bonds are currently yielding only 3%. As a result, the Euro has risen in value during the period.

    There is a significant dichotomy, therefore, between official central bank interest rates, as they have tried to keep asset prices and property inflated, with a corresponding fall in the yields on those assets, compared to the actual market rates of interest that borrowers face in a whole range of areas, unrelated to property or financial speculation, including the prices of the commercial bonds of the major corporations that have themselves been inflated. As Marx describes, central banks are in a stronger position to influence interest rates, where the market is already tight, and the central bank seeks to raise interest rates, because to do so they merely have to withdraw liquidity. Even then, as Marx describes, businesses can respond in times of vibrant economic activity by increasing the use of commercial credit, as a replacement for currency.

    Marx cites in that respect a discussion in the Banking Committee,

    “5306. If there should not be currency to settle the transactions at the clearing house, the only next alternative which I can see is to meet together, and to make our payments in first-class bills, bills upon the Treasury, and Messrs. Smith, Payne, and so forth.” — “5307. Then, if the government failed to supply you with a circulating medium, you would create one for yourselves? — What can we do? The public come in, and take the circulating medium out of our hands; it does not exist.” — “5308. You would only then do in London what they do in Manchester every day of the week? — Yes.”

    (Capital III, Chapter 33)

    As Marx points out, it is a myth put out by the bankers that all money loaned out by the banks is capital rather than currency, and still less is it capital that belongs to the bank itself. Actual money-capital is continually being produced as a consequence of the profits made by companies, and it is those realised profits which provide the additional supply of loanable money-capital. If the central bank raises rates at a time when businesses seek to demand additional money-capital to invest, then businesses will have an incentive to use more of their profits to invest in that productive-capital directly, rather than borrow it, or else they will use their own money hoards and reserves, stored in their bank accounts for that purpose.
    And now, with an increasing proportion of the economy being highly banked, and with electronic transactions replacing actual money tokens as currency, the ability of a central bank to influence actual market rates of interest, as opposed to the prices of financial assets, by withdrawing or adding liquidity is even more limited. Indeed, as Marx sets out, the idea that the rate of interest is a function of the supply of money, is another myth put out by the bankers. As he sets out in Theories of Surplus Value, no such influence on the rate of interest is possible.

    Marx quotes Massie and Hume to that effect.

    “Hume attacks Locke, Massie attacks both Petty and Locke, both of whom still held the view that the level of interest depends on the quantity of money, and that in fact the real object of the loan is money (not capital).

    Massie laid down more categorically than did Hume, that interest is merely a part of profit. Hume is mainly concerned to show that the value of money makes no difference to the rate of interest, since, given the proportion between interest and money-capital—6 per cent for example, that is, £6, rises or falls in value at the same time as the value of the £100 (and. therefore, of one pound sterling) rises or falls, but the proportion 6 is not affected by this.”

    If central bankers could determine the price of money-capital (the rate of interest) then they could equally well determine the price of every other commodity!

    As Marx sets out, no such control of market rates of interest is possible by the central bank.

    “The power of the Bank of England is revealed by its regulation of the market rate of interest. In times of normal activity, it may happen that the Bank cannot prevent a moderate drain of gold from its bullion reserve by raising the discount rate because the demand for means of payment is satisfied by private banks, stock banks and bill-brokers, who have gained considerably in capital power during the last thirty years. In such case, the Bank of England must have recourse to other means. But the statement made by banker Glyn (of Glyn, Mills, Currie & Co.) before the C. D. 1848/57 still holds good for critical periods:

    “1709. Under circumstances of great pressure upon the country the Bank of England commands the rate of interest.” — “1740. In times of extraordinary pressure … whenever the discounts of the private bankers or brokers become comparatively limited, they fall upon the Bank of England, and then it is that the Bank of England has the power of commanding the market rate.””

    And in a note Engels notes,

    “At the general meeting of stockholders of the Union Bank of London on January 17, 1894, President Ritchie relates that the Bank of England raised the discount in 1893 from 2½% in July to 3 and 4% in August, and since it lost within four weeks fully £4½ million in gold despite this, it raised the bank-rate to 5%, whereupon gold flowed back to it and the bank rate was reduced to 4% in September and then to 3% in October. But this bank-rate was not recognised in the market. “When the bank-rate was 5%, the discount rate was 3½%, and the rate for money 2½%; when the bank-rate fell to 4%, the discount rate was 2 3/8% and the money rate 1¾%; when the bank-rate was 3%, the discount rate fell to 1½% and the money rate to something below that.” (Daily News, January 18, 1894.) — F.E.”

    For the Bank of England, therefore, we may well see that it doubles its official interest rate from 0.25% to 0.50%, but that this results in coming weeks and months in speculators selling Gilts, as they no longer feel they have the security of the Bank of England standing behind them. The consequence would then be a drain of money out of UK financial assets, possibly to German Bunds. The effect would then be a a further fall in the value of the Pound, which is already susceptible due to Brexit. Further falls in the Pound, then cause UK inflation to rise further, at a time when it is already 50% above the BoE target, and when wages are being squeezed as Brexit is causing a stagnation of the UK economy.

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