IT HAS recently emerged that a UK bank has been manipulating a key interest rate. The only disappointment I have is that people are wasting so much energy on the wrong bank and the wrong interest rate. The Bank of England has far more influence over the banking system than Barclays – it is, after all, the central bank. And the Bank rate, the interest rate that the Bank of England sets each month, is in many ways a hugely more important benchmark than Libor.
One might even argue that Barclays was doing us a favour. If it emerges that it was keeping interest rates higher than they otherwise would have been, this would have reduced the scale of the asset bubble that the Bank of England’s artificially low rates were creating. If only other financial institutions had been offsetting the main cause of the financial crisis.
And if it was keeping rates lower, it was merely adopting government policy and keeping mortgage costs low. My recollection of 2008 was that a spiking Libor was being actively dampened by policy-makers, although exactly what happened hasn’t been revealed yet. One thing we do know is that Libor needs to be calculated properly, without relying on a sample of individual firms’ reported data. This always made it prone to abuse.
Of course, the main difference between what Barclays is accused of doing and what the Bank of England routinely does is democratic legitimacy. In short, the Bank is allowed to manipulate interest rates. But a vital issue remains unresolved.
There is a severe knowledge problem. Manipulating interest rates – like manipulating any market price – deprives us of truth.
On Twitter recently, Danny Blanchflower, former member of the Monetary Policy Committee and Andrew Lilico, the chairman of Europe Economics, debated what the “natural interest rate” currently is. This is the interest rate that would generate sustainable economic growth with a balance between people’s desire for savings and investment. It is the reference point around which loose or tight monetary policy can be defined.
Blanchflower thought it was -3 per cent, while Lilico thought it was around +3 per cent. The problem is that none of us really know. Whether it’s the Bank of England manipulating the Bank rate, or Barclays manipulating Libor, we aren’t even attempting to use markets to learn about reality. It’s almost like we’ve forgotten that interest rates can tell us something new, rather than simply reflect what we wish them to be.
In reality Barclays is a minor player because the whole monetary system is built on the desire of central banks to impose their wishes on the market. But to kill an octopus you don’t trim its tentacles. You need to cut off its head.
Anthony J. Evans is associate professor of economics at ESCP Europe Business School. www.anthonyjevans.com Twitter: @anthonyjevans