On Tuesday 16th of February, the Durham University Economics Society held its first speaker event of the year. Mauricio Armellini, the Bank of England’s Agent for the North East spoke about United Kingdom's economy from the perspective of the Bank of England. Mauricio is an economist from Uruguay who came to the UK after graduating from Williams college (USA), where he did his MA in Development Economics. He then did his PhD in economics at Durham University and later taught here. In 2008 he joined the Department for Work and Pensions where he led teams of analysts in various areas, such as skills and pensions. In 2013 he went on secondment to the North East Local Enterprise partnership working as Chief Economist and after a year he was appointed as Bank of England’s Agent for the North East.
The Bank of England, founded in 1694, is the central bank of the United Kingdom. Its integral purpose is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability. The bank is responsible for a number of roles and plays an imperative one in ensuring economic stability. For instance, the bank’s Monetary Policy Committee, which is entrusted with the crucial job of setting interest rates, is made up of 9 members of whom 4 are external members. According to Mauricio, independent members complement the MPC’s work by bringing thinking and expertise from outside of the Bank of England. Every month the committee meets to determine interest rates and since 2009 it has maintained a constant rate of 0.5%, a record low. At the last meeting, on 4th of February, all 9 members of the MPC voted to maintain the rate of interest at 0.5%. However, there is a strong belief among the members that the next step will be to raise rather than decrease the interest rate.
Why is the Bank of England holding the rate of interest so close to zero? What are the economic factors underlying and justifying such actions of the bank? Mauricio Armellini briefly explained 4 factors that shape the policy of the Bank of England.
Factor 1 – Global growth. In the past 3 months, world economic growth has fallen. The International Monetary Fund reported that the growth of world output would be 0.2 points lower in 2016 and 2017 compared with forecasts made a few months ago. The IMF forecasts that the global economy will grow by 3.4% and 3.6% in 2016 and 2017 respectively. The factors that have contributed to this downgrade in forecast include: financial market volatility, unstable price of oil, and the stagnation in China’s growth rate. In addition, various geopolitical crises such as the refugee crisis in Europe and Britain’s potential exit from the EU present their own risks.
Factor 2 – Household and corporate spending. With housing investments decreasing in 2015 and business investments remaining strong, the bank forecasts household and corporate spending to remain robust and resilient. A fact worth mentioning is that banks are more careful now than in the pre-recession years, therefore it is much harder to get a mortgage after the crisis. In spite of that, housing prices are growing at an annual rate of 7% and are expected to remain in this region over the next few years.
Factor 3 – Productivity. Despite stagnating and dipping in the years of recession, productivity growth is expected to pick up a little bit further. Currently at 1% it is expected to be between 1 and .75% in 2018. Mauricio explained the reason behind this expected decline as this: in the recovery years firms, unemployment was high and firms were hiring people at a rapid rate to take advantage of growth, even though there was no need. With unemployment now at 5% and falling, firms have to find ways to increase productivity to achieve further growth.
Factor 4 – Domestic costs and inflation. Most recent data has shown that inflation is currently at 0.3% far from the government’s set 2% target. However, the oil prices are not expected to fall further, and so inflation is expected to return to 2% in two years’ time.
Having a responsibility to achieve the set target of inflation (2%), BoE has no choice but to keep the rate of interest low till inflation reaches the desired level. Why is 2% a desired inflation rate if politicians speak of how beneficial the 0.3% inflation is? Households might find that with low inflation and rising wages their disposable income is rising faster, but economists argue that higher rate of inflation allows flexibility in relevant prices and also prevents the risk of falling into a deflationary spiral, Japan being a prime example in recent times of the damage deflation can inflict upon an economy.
Whilst the mistakes of Central Banks can provoke financial disasters, intelligent decisions may drag economies out of recessions. Mauricio Armellini convinced us that the Bank of England has contributed towards restored growth in the United Kingdom and has further encouraged higher economic growth rates, bringing with them better standards of living and prosperity to all.
Image from:
http://www.geograph.org.uk/photo/3898553
