Good article on monetary policy, with 4 good evaluation points:

We are in danger of becoming addicted to low interest rates

• ANDREW SENTANCE

25 MARCH 2016 • 1:58PM

The returns available to savers have been depressed for many years now CREDIT: ALAMY

This month, we passed the seventh anniversary of the Monetary Policy Committee’s decision to reduce the official Bank Rate to 0.5pc, the lowest level in UK monetary history. Because the EU Referendum and the Budget have been dominating the economic and financial headlines, this anniversary passed almost unnoticed.  However, we have not seen a period of such prolonged low interest rates here in the UK since the 1930s and 1940s. Then, the Bank of England’s official interest rate was held at 2pc from 1932 until 1951 – initially to respond to the problems of the Great Depression and subsequently because of the impact of the Second World War.

Apart from the 1930s and 1940s, I cannot find any period since the Bank was founded in 1694 when interest rates have been held at 2pc or below for as long as the last seven years. So we are living in very unusual times for monetary policy.

I was a member of the MPC when we cut interest rates to 0.5pc in March 2009 and embarked on the policy of Quantitative Easing. It was the right thing to do at that time because of the deepening financial crisis and the need to provide a boost to consumer and business confidence.

But the UK and the world economy have moved on a long way since then. We are now in the seventh year of economic recovery. UK unemployment has been falling fairly consistently for more than four years and the jobless rate is now below its pre-crisis level. The British economy has been either first or second in the G7 league table since 2013 and is likely to occupy one of the top two slots this year as well.

So why are we stuck at a level of interest rates which was set to respond to an economic and financial emergency in 2009? The usual answer to this question is that there is no immediate need to raise interest rates. We are in a low interest rate environment worldwide – not just in the UK – and there are many uncertainties affecting the global economic outlook. In addition, inflation remains subdued, particularly since the recent falls in the oil price.

However, this line of thinking does not take into account the potential problems which a prolonged period of very low interest rates may be creating for the economy at the same time.

There are four key negative consequences for the economy which should be concerning central banks around the world.

First, the returns available to savers have been depressed for many years now, while inflation has continued to erode the value of savings. Despite being very low recently, average inflation since interest rates were cut to 0.5pc has been over 2pc. A situation where real (ie inflation-adjusted) interest rates are negative means the value of savings is being eroded over time, not increasing. This offers poor incentives to individuals to save for the future and makes it increasingly difficult for people to provide an adequate income in retirement. While a temporary period of low interest rates can be tolerated by savers, if this persists for many years it risks undermining the notion that saving is a worthwhile and productive activity.

 Second, low interest rates encourage consumers to take on more debt – precisely the problem which created the difficulties that led to the financial crisis in the first place. Unsecured lending - such as overdrafts, bank loans and credit card debt - is already growing at about 6pc, according to the latest figures. The British Bankers’ Association said last week: “Households are increasingly taking advantage of low interest rates by taking on more unsecured borrowing.” Mortgage borrowing has also been picking over the past two to three years.

Third, house prices are being pushed up – particularly in London and the South East – by the availability of cheap money. Official figures last week showed that UK property prices were nearly 8pc higher than a year ago. The average UK house price is now worth nearly £300,000. While people who are already homeowners continue to benefit from low interest rates, high house price inflation penalises younger people trying to get on the first rungs of the housing ladder – the so-called “Generation Rent”.

Fourth, the longer we continue at the current level of interest rates, the more likely it is that businesses and individuals treat this as the normal state of affairs. That makes it harder for the Bank or other central banks to wean the economy off the monetary medicine and establish a level of interest rates which is in line with or higher than inflation. The longer this period of very low borrowing costs continues, the greater the risk we develop an economy addicted to extremely low interest rates, in which even a small rise in rates is seen as a big shock to the system.

House prices are being pushed up – particularly in London and the South East – by the availability of cheap money

To avoid getting caught in this trap, central banks in economies which are performing reasonably well, like the UK and the US, cannot afford to delay much longer. Indeed, the Federal Reserve started the process of raising the US interest rate in December, and a number of policy-makers are now suggesting there could be another upward move in April.

In the UK, the Bank should be taking the opportunity afforded by rising interest rates in the US to make the first moves here too, though the uncertainty created by the EU Referendum is likely to prevent any decision until after June.

There will always be some short-term reason for delaying a rise in interest rates after such a long period at near-zero levels. The current issues which seem to be holding back the Bank are uncertainty about parts of the global economy and low inflation. But waiting until all the indicators are flashing red and pointing to the urgent need for higher interest rates means it has almost certainly been left too late.

The job of an independent central bank is to take a long-term view and to look beyond the short-term fluctuations and uncertainties. That means taking account of the negative consequences of a prolonged period of exceptionally low savings returns and borrowing costs and not continually postponing the process of gradually returning interest rates to more normal levels.

Andrew Sentance is senior economic adviser at PwC and a former member of the Monetary Policy Committee