Saturday, 5 February 2011

The perverse effects of raising interest rates

We're starting to get calls from certain quarters to raise interest rates to 'quell inflation'. However according to research that would trigger a perverse effect.

When the central bank puts interest rates up there is a short term boost to the economy - increasing demand.

This is caused by savers getting more money from borrowers and increasing spending, whereas fixed rate borrowers don't change anything and variable rate borrowers fail to cut back as quickly (often taking eighteen months or so to scale back).

And all this appears to be linked to the 'saving/borrowing' ratio. Where there is a lot of domestic saving the perverse effect can last for a lot longer.