Economics 101

  • Thread starter averagechapinthestreet
  • Start date

A

averagechapinthestreet

Hi,

Could anyone please explain in fairly simple terms the answer to these
two questions which baffle me (and my economically-allergic mind)?

Inflation: there are many stories doing the rounds currently about
various service providers (water and energy companies are the most
recent) putting their prices up by x% above the inflation rate.
Similarly we hear of fuel costs, food staples etc. again going up by
more than the inflation rate. My question is, don't these things
actually represent the rate of inflation? Inflation is the rate at
which prices increase for a given item/service, no? If they,
empirically, are rising faster than some arbitrary figure on a piece
of paper surely the figure must be wrong?

Second question: house sales are down, house prices are down, shops
complain that customers are deserting them and there are many more
tales of gloom. Why doesn't the Bank of England reduce the interest
rate? It would put more money into the pockets of mortgage-payers
(though reduce income for savers, obviously) and reduce pressure on
employers to raise wages - everyone wins. I suspect this is far too
simple though!

Andy.
 
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Y

Yellow

[averagechapinthestreet@inbox.com] said:
Hi,

Could anyone please explain in fairly simple terms the answer to these
two questions which baffle me (and my economically-allergic mind)?

Inflation: there are many stories doing the rounds currently about
various service providers (water and energy companies are the most
recent) putting their prices up by x% above the inflation rate.
Similarly we hear of fuel costs, food staples etc. again going up by
more than the inflation rate. My question is, don't these things
actually represent the rate of inflation? Inflation is the rate at
which prices increase for a given item/service, no? If they,
empirically, are rising faster than some arbitrary figure on a piece
of paper surely the figure must be wrong?

Second question: house sales are down, house prices are down, shops
complain that customers are deserting them and there are many more
tales of gloom. Why doesn't the Bank of England reduce the interest
rate? It would put more money into the pockets of mortgage-payers
(though reduce income for savers, obviously) and reduce pressure on
employers to raise wages - everyone wins. I suspect this is far too
simple though!
Reducing income for savers is hardly everyone winning, is it.
 
A

Andrew MacPherson

Why doesn't the Bank of England reduce the interest
rate?
Real wealth comes from (a) savings (b) making stuff/services other people
want to buy. And the latter's in relatively short supply in the UK these
days.

Given that we've maxed out the UK's collective credit card, making us an
increasingly unattractive bet for foreign investors (who've extended an
ever larger overdraft to us for much of the last decade) banks need to
attract more money, not less.

Even if the BoE dropped rates, banks couldn't because that would
encourage savers like me to take out their money and put it into precious
metals, baked beans (I have some in the cupboard which have appreciated
by more than 100% this year!) or even shares. As bank reserves are
already dangerously low (hence regular central bank intervention) that's
not going to happen.

Andrew McP
 
A

averagechapinthestreet

[averagechapinthestr...@inbox.com] said:


Could anyone please explain in fairly simple terms the answer to these
two questions which baffle me (and my economically-allergic mind)?
Inflation: there are many stories doing the rounds currently about
various service providers (water and energy companies are the most
recent) putting their prices up by x% above the inflation rate.
Similarly we hear of fuel costs, food staples etc. again going up by
more than the inflation rate. My question is, don't these things
actually represent the rate of inflation? Inflation is the rate at
which prices increase for a given item/service, no? If they,
empirically, are rising faster than some arbitrary figure on a piece
of paper surely the figure must be wrong?
Second question: house sales are down, house prices are down, shops
complain that customers are deserting them and there are many more
tales of gloom. Why doesn't the Bank of England reduce the interest
rate? It would put more money into the pockets of mortgage-payers
(though reduce income for savers, obviously) and reduce pressure on
employers to raise wages - everyone wins. I suspect this is far too
simple though!
Reducing income for savers is hardly everyone winning, is it.
I suspect that would very much depend on whether the corresponding
reduction in mortgage payment, loan or any other interest rate-
dependent outgoing is greater than the amount 'lost' in lower savings
returns. But thanks for your comment.

Andy.
 
M

M Holmes

I suspect that would very much depend on whether the corresponding
reduction in mortgage payment, loan or any other interest rate-
dependent outgoing is greater than the amount 'lost' in lower savings
returns. But thanks for your comment.
The thing that's being missed here is that the BofE (and the fed for
that matter) no longer decides mortgage rates. The BofE and federal
reserve both cut rates for the credit bust (the fed cut them into
negative real territory). however mortgage rates, as predicted, went up.

The trouble with going into too much debt is that there's a point at
which the creditor, rather than any political control, decides the
interest rate. Either you pay it, or you do settle your debts and do
without the ongoing credit. The bondholders of mortgage-backs, CDOs etc
have discovered they were carrying far more risk than was previously
supposed, and are demanding compensation for that risk in the form of
higher mortgage rates.

In the UK, as mortgagees are discovering, they can either pay those
rates or go without. Given the collapse in new mortgages, and the
number of people who cannot remortgage after their teaser deals are
over, many are going without. The rest are paying higher rates.

Now that mortgage securitisation is all but dead, the anks will have to
rely on savers to gain the funds to make mortgages. Under Labour, the
savings rate collapsed from near 10% to a mere 1%. To get savings rates
up, and garner the means to make more mortgages, and more profits, the
bans will have to raise savings rates and thus raise mortgage rates yt
further. The Bank of England has little control over this: if they cut
rates to savers, they'll save less and therefore there will be less
money for mortgages and an eveen faster housing collapse.

Over in the US there are some additional wrinkles. The subprime
mortgage markets, which were there because nobody could compete with
Fannie Mae and Freddie Mac in prime markets, have all but collapsed,
having reached default rates of over 18% of mortgages and causing mass
damage to even the super-senior tranches of CDOs while wiping out the
lower tranches. Fannie announced yesterday that they were quittng
the Alt-A mortgage market (above subprime but below prime), killing
another 12% of US mortgages. Essentially the half of US mortgage markets
not guaranteed and securitised by Freddie and Fannie is now closed for
business.

We know that Fannie and Freddie, as long-predicted, are in serious
trouble. One ex Fed governor says that Freddie has a negative net worth.
They're both paying agents to keep dead mortgagees in their houses so
that they don't have to pay out on guarantees of capital and interest to
the owner of the mortgages. Given that they guarantee near six trillion
Dollars of mortgages, that behaviour is worrying.

Meanwhile, due to the fact that there are now losses on prime mortgages
too (affecting those guarantees) Fannie and Freddie are hiking the fees
they charge to guarantee new mortgages and are charging higher interest
rates on mortgages. That means that irrespective of what the Fed does,
mortgage rates will be going up in the US too.

The long and the short of it was that it was the biggest credit bubble
in history and it's going to be decades at least before we credit
availability like that again. Mortgages in the meanwhile (assuming that
they continue to exist en-masse, which is no longer a given) will be
dependent on savers. The only solution to the availability problem in
the long run is thus to hike interest rates to increase savings. That
will mean higher mortgage rates for the much fewer people who will have
mortgages. Inasmuch as the banks will have to ration the funds they do
have, they will protect themselves from defaults by requiring people to
save with the banks for a period before getting a mortgage, and will
kost likely move to requiring a deposit of somewhere between 25% and 50%
of the house price.

When we get through all this, and it will take a while, that will be the
new normal.

FoFP
 
T

Toom Tabard

Hi,

Could anyone please explain in fairly simple terms the answer to these
two questions which baffle me (and my economically-allergic mind)?

Inflation: there are many stories doing the rounds currently about
various service providers (water and energy companies are the most
recent) putting their prices up by x% above the inflation rate.
Similarly we hear of fuel costs, food staples etc. again going up by
more than the inflation rate.  My question is, don't these things
actually represent the rate of inflation?  Inflation is the rate at
which prices increase for a given item/service, no?  If they,
empirically, are rising faster than some arbitrary figure on a piece
of paper surely the figure must be wrong?
When they are talking about the rate of inflation, they usually mean
one of the standard government measures - the retail price index (RPI)
or the consumer price index (CPI). These assume that you buy a package
of products including several flatscreen tvs, six MP3 players and a
new mobile phone, etc, each month. This reduces the apparent rate of
inflation to the current 4.4%, and ensures that e.g pensioners who
spend most of their money on food, fuel, council tax, and who might
find their actual inflation is 20%, can be given a 4.4% increase in
their 'inflation proof' pension to adequately compensate them.
Second question: house sales are down, house prices are down, shops
complain that customers are deserting them and there are many more
tales of gloom.  Why doesn't the Bank of England reduce the interest
rate?  It would put more money into the pockets of mortgage-payers
(though reduce income for savers, obviously) and reduce pressure on
employers to raise wages - everyone wins.  I suspect this is far too
simple though!
Making money available at cheaper rates increases inflation. It was
e.g. easy loans for ridiculous multiples of salary which resulted in
stupid amounts being bid for houses, i.e. house price inflation.

The basic problem is that our recent unprecedented period of sustained
economic growth was actually an unprecedented period of sustained
increase in borrowing, which has the same initial illusion of success,
and the same ultimate sustainability, as a pyramid selling scheme. It
was, as usual, 'different this time', except that it wasn't. Instead
of see-sawing between boom and bust, we've gone from fantastic boom
and are in the early stages of fantastic bust. Reducing interest rates
now would just re-inflate the balloon. Lending only works if the
borrowers eventually give the money back. People have been lent too
much and other factors have now made it doubtful if they can repay, so
borrowers want their money back and will only lend money in small
amounts at their own higher rates (not the B of E rate) to people who
seem likely to be able to repay.

Toom
 
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S

Sam Smith

empirically, are rising faster than some arbitrary figure on a piece
of paper surely the figure must be wrong?
No. The inflation figures are an average based on previous data.

Yes each increase will be included in the next round of inflation
figures but the current figure is an average based on the inflation
shopping basket of items calculated for the previous month.
Second question: house sales are down, house prices are down, shops
complain that customers are deserting them and there are many more
tales of gloom. Why doesn't the Bank of England reduce the interest
rate? It would put more money into the pockets of mortgage-payers
(though reduce income for savers, obviously) and reduce pressure on
employers to raise wages - everyone wins.
Lowering interest rates is not a quick fix to this problem. Lowering
rates reduces the value of the pound therefore making imports (oil etc.)
far more expensive so everyone potentially looses. Rates are a balancing
act. On one hand lowering them makes mortgage payers instantly happy as
they may (unless they are on fixed rates) pay less next month. But a
slightly longer term problem is that the same mortgage payer may
suddenly have to pay more for their petrol and other items as inflation
gets more out of control due to interest rates being set too low. As the
majority of mortgage payers are on fixed rate mortgages a lowering of
the rate may actually be more harmful to them. The one thing that
lowering rates does though is to make it easier for more people to climb
into the housing market therefore inflating the price of property and
making those self-same fixed rate mortgage payers feel richer. This in
turn stimulates them to borrow more on their houses and they may feel
better off.

However - you cannot build a sustainable economy on borrowing.

Unfortunately that is exactly what the UK economy has been based upon.
Houses prices should have been included in the inflation statistics
thereby applying a natural braking effect to prices before they went
stratospheric and preventing people from over-stretching themselves.
Traditionally banks provided this braking effect through prudence and
common sense - but that seems to have gone out of the window for the
past 5-10 years and coupled with interest rates that were left too low
for too long - has left us in this situation.

Had interest rates been prevented from going so low and stayed around
the 7% mark the housing boom would have been far more subdued (banks
would still have been reckless but that could have been prevented by
having a better FSA). This in turn would have meant fewer people over
stretching themselves therefore reducing the debt burden by not creating
it in the first place. You would have had a few less property tycoons
and well paid bankers but the vast majority of people would have been
safe. Sure people would have had to spend more within their means - a
few less expensive cars and holidays - but in the mid to long term they
would have been happier and better off.

When an economy is built on a combination of borrowing, prudence and
genuine savings you then have the flexibility to deal with the current
global slowdown. With interest rates already set higher inflation would
be far more under control. You would then have scope for gently reducing
rates to cope with the world downturn instead of what we did in keeping
them reduced all through the good years too.

Economic management isn't really all that complicated - things that are
successful rarely are - it's just that people find it difficult to
change potential boom into more subdued financial prudence and instead
prefer to let it run for as long as possible which ends in the
inevitable crash at the end.
 
Y

Yellow

[averagechapinthestreet@inbox.com] said:
I suspect that would very much depend on whether the corresponding
reduction in mortgage payment, loan or any other interest rate-
dependent outgoing is greater than the amount 'lost' in lower savings
returns.
Indeed but not everyone has a mortgage and anyone with more than a few
thousand in the "bank" is hardly likely to be paying anyone else
interest unless it is unavoidable.
But thanks for your comment.
You are very welcome but I think you will find this is kind of how
usenet works meaning that there is no need to thank contributors to the
group on an individual basis. :)
 
A

averagechapinthestreet

When they are talking about the rate of inflation, they usually mean
one of the standard government measures - the retail price index (RPI)
or the consumer price index (CPI). These assume that you buy a package
of products including several flatscreen tvs, six MP3 players and a
new mobile phone, etc, each month.

------------------------------------------------------------------------------------------------

In case it isn't obvious, Toom is exaggerating

The actual numbers (or something close) is here:

http://www.statistics.gov.uk/CCI/article.asp?ID=1951
Now that is interesting! Fascinating to see that TV repair is out, as
are 'stubbies' (in favour of full-size beer bottles), and muffins are
in along with fresh peppers. I'll make a note to keep an eye on it in
future. If this is what effectively drives the interest rate (RPI),
and assuming that the evidence collected is done so in a way that is
representative of the actual real-life shopper, then I should fully
expect to see a sizeable rise in the figure.

Thanks to everyone who replied; things are a bit clearer now but I
still can't help thinking that it all seems like a bit of a game: I
know that raw material costs, including transportation costs, are
going up but there is still something about the influence that reduced
demand *should* have on final sales price, i.e. it should push it
down. I'm going to read more on this - I obviously don't know
anywhere near enough.

Andy.
 
J

Jonathan Bryce

Sam said:
Lowering interest rates is not a quick fix to this problem. Lowering
rates reduces the value of the pound therefore making imports (oil etc.)
far more expensive so everyone potentially looses. Rates are a balancing
act. On one hand lowering them makes mortgage payers instantly happy as
they may (unless they are on fixed rates) pay less next month. But a
slightly longer term problem is that the same mortgage payer may
suddenly have to pay more for their petrol and other items as inflation
gets more out of control due to interest rates being set too low. As the
majority of mortgage payers are on fixed rate mortgages a lowering of
the rate may actually be more harmful to them. The one thing that
lowering rates does though is to make it easier for more people to climb
into the housing market therefore inflating the price of property and
making those self-same fixed rate mortgage payers feel richer. This in
turn stimulates them to borrow more on their houses and they may feel
better off.
Also, mortgage rates in America seem to be higher than they are here,
despite the base rate being 2% there and 5% here. It is debateable how
much control the Bank of England or the Federal Reserve actually have over
the bank rates that you and I actually pay or receive at the moment.
 
T

Tim

... It is debateable how much control the Bank of England
or the Federal Reserve actually have over the bank rates
that you and I actually pay or receive at the moment.
There's no debate over the rate I pay on my mortgage - the
BoE has *full* control over that. It's linked to their Base Rate!
 
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R

Ronald Raygun

Tim said:
There's no debate over the rate I pay on my mortgage - the
BoE has *full* control over that. It's linked to their Base Rate!
If push came to shove, your bank would not hesitate to break that
link. It's unlikely that the loan agreement would bind them to
keep the link for the full duration of the originally agreed loan
term. Naturally if you didn't like it, you would be given the
opportunity to repay the loan without penalty.
 
T

Tim

If push came to shove, your bank
would not hesitate to break that link. ...
I kinda doubt that, really...

... It's unlikely that the loan agreement would bind them to keep
the link for the full duration of the originally agreed loan term. ...
The loan agreement guarantees that the rate
won't go a certain percentage over BoE base.
I think they've stopped giving that guarantee
now, but it was written into my agreement!
 
R

Ronald Raygun

Tim said:
I kinda doubt that, really...
Why?


The loan agreement guarantees that the rate
won't go a certain percentage over BoE base.
I think they've stopped giving that guarantee
now, but it was written into my agreement!
But that guarantee doesn't last forever, does it?
 
T

Tim

Because it's written into the agreement, so they
wouldn't be able to enforce breaking the link.
But that guarantee doesn't last forever, does it?
You're right, of course. It ends at the end of the term of the mortgage.
 
R

Ronald Raygun

Tim said:
You're right, of course. It ends at the end of the term of the mortgage.
In context that's what forever means. Are you sure there is no small
print in the agreement which permits them to unilaterally change the
terms, giving you the chance to take your business elsewhere if the
change is to your disadvantage?
 
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J

Jonathan Bryce

Tim said:
There's no debate over the rate I pay on my mortgage - the
BoE has *full* control over that. It's linked to their Base Rate!
Yes, but for new business, you might find that the tracker loans have a
higher margin over base rate.
 
T

Tim

The loan agreement guarantees that the rate
"Ronald Raygun" wrote
In context that's what forever means. Are you sure there
is no small print in the agreement which permits them to
unilaterally change the terms, giving you the chance to take
your business elsewhere if the change is to your disadvantage?
It wouldn't be a *guarantee* then though, would it?

I'll try to get round to digging out the agreement sometime
to check, but I don't think that they do have that right (and I
did read the entire agreement thoroughly before signing it!).
 
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