Thursday 15 September 2016 5:45 pm

As the Bank of England holds interest rates, is ultra-loose monetary policy a danger to financial stability?

Baroness Altmann is the former minister of state for pensions.
and Ben Southwood

Baroness Altmann, a former pensions minister, says Yes.

The Bank’s monetary policy is not only a potentially serious danger to financial stability, it also has damaging side effects that call into question the extent of easing it actually represents.

The fallout from years of pushing both short and long rates lower is that capital markets and asset prices have been artificially distorted, borrowers have taken on ever larger loans, and many long-term savers are taking on much more risk than they may realise.

The Bank has created billions of pounds of new money in order to buy gilts – it aims to artificially influence the supposedly “risk free” interest rate. Investment risk models use this rate as a benchmark against which other asset prices and risk characteristics are based. And while the Bank is hoovering up gilts, it is also competing with institutions, which are often required by regulators to increase gilt holdings. So the gilt yield may be doubly distorted.

The gilt market seems to be in a bubble. That means all other assets may too be in bubble territory. If or when such bubbles burst, there is bound to be financial instability.

Ben Southwood, head of research at the Adam Smith Institute, says No.

Ultra-loose monetary policy might be a threat to financial stability, but it’s not what we’ve got. In the words of Milton Friedman: “low interest rates are a sign that money has been tight”. And in the words of Ben Bernanke, “nominal interest rates are not good indicators of the stance of policy”.

The Bank’s 0.25 per cent base interest rate does not mean easy money. Rates are usually low because inflation is expected to be low, in turn because there is insufficient demand in the economy. Excessively tight money is as dangerous as excessively easy money: inflation that consistently falls below target for demand-side reasons deters firms from investing and employing.

Unemployment is as low as it’s been for decades and the employment rate is at a record high. Our focus should now be on solving supply-side problems – particularly why productivity is growing so slowly. But we needn’t add to supply-side struggles with a separate demand-side problem, by tightening policy and creating a Eurozone-like deflationary crisis.

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