Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

UK official interest rate at 315 year low

Last week, the UK reduced its interest rate to the lowest level
ever in its 315 year history. I found this surprising since there is
very little in terms of economic environment that the Bank of England
has not seen in these three centuries. It is all the more puzzling
when the interest rate graph is juxtaposed with a graph of inflation
rates (see figures below).

BOE official rates

UK-inflation.png

It is interesting to see that negative inflation rates are quite
common prior to the twentieth century. The average inflation
rate was negative in the entire nineteenth century. But even in this
period, while interest rates went down to 2% on several occasions,
they never dropped to the 1.5% level reached last week.

What is also interesting is that for 103 years from 1719 to 1822,
the Bank of England did not change its rate even once. England lost an
empire in one continent while gaining an empire in another; it fought
the Seven Years War and the Napoleonic wars; inflation rates ranged
from +30% to -23%, but interest rates remained fixed at 5%!

Deflation was quite common in the eighteenth and nineteenth
centuries, and apparently was not damaging to growth. Perhaps, there
is something pernicious about fiat (paper) money that makes inflation
and deflation so scary. Under the gold standard, the price level had a
tendency to mean revert so that high inflation was followed quickly by
deflation; therefore even 30% inflation did not create inflationary
expectations, and even 20% deflation did not create deflationary
expectations.

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One response to “UK official interest rate at 315 year low

  1. Mahesh January 13, 2009 at 1:11 am

    dear Mr.Varma,
    An analysis based on this kind of a term is solidly reliable rather than the really short term data used for analysis nowadays for business and economic decisions. This has reference to finance teaching in MBA institutes you had mentioned in your earlier posts. Haste makes waste!
    Regards
    Mahesh

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