How should interest rates be set?

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The economy would benefit from a weaker Bank of England, stripped of its principal power to set interest rates. No one should be allowed to set interest rates. Interest rates are simply prices of borrowing. As with all prices they should be determined with market mechanisms. When they are set by a ‘wise man’, or by a ‘wise committee’, they do not carry the information about the preferences of consumers and the scarcity of resources. Quite the opposite, interest rates set in this way are bound to be a kind of misinformation, leading those who act on them into error.

Take for example a car tyre. In a free market, the price mechanism would find the optimum price for the tyre to be supplied and consumed at, in order that it is allocated efficiently. If the price of the tyre is fixed higher than this price, then tyres will be under consumed; similarly, if it were fixed below this price, the firms would not be able to meet the excessive demand. In both instances, the resources are not allocated as efficiently as they could be.

This also applies to money. Suppose the demand for borrowing rose. This would increase competition for access to the scarce supply of savings and drive up interest rates. Saving would now be more rewarding, so more people would do it, and the supply of savings would rise. However, when interest rates are set by a central bank, demand for borrowing can increase without interest rates changing and moreover without the price signal that would cause people to save more. When dictated, interest rates stop playing their market role of optimally allocating resources between current consumption, and investment that will deliver future consumption.

Had interest rates been set by the free market, interest rates would not have been so low for so long, and this recession would have been a lot less damaging.

Much of the argument for this blog was inspired by this piece in The Times by Jamie Whyte.

Authors against the database state

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Anthony Horowitz, Anne Fine, Quentin Blake, Philip Pullman and Michael Morpurgo will stop visiting schools in protest over the government’s desire to put them on a database. This is part of the Vetting and Barring Scheme (VBS), managed by one of those pesky quangos, the Independent Safeguarding Authority. One for the dustbin, I suggest, Mr Cameron.

Respected author Philip Pullman has described the policy as “corrosive and poisonous to every kind of healthy social interaction." He went on to state: “I've been going into schools as an author for 20 years, and on no occasion have I ever been alone with a child. The idea that I have become more of a threat and I need to be vetted is both ludicrous and insulting. Children have never been in any danger from visiting authors or illustrators, and the idea that they should be is preposterous."

Former Children's Laureate Anne Fine has set out that: "When it [the VBS] becomes essential, I shall continue to work only in foreign schools, where sanity prevails…The whole idea of vetting an adult who visits many schools, but each only for a day, and then always in the presence of other adults, is deeply offensive."

Anthony Horowitz hits the nail on the head in questioning the thinking behind this move: “What I really hate about this database is the way it poisons the very special relationship that exists between children and the authors they admire. What sort of sick mind could whisper that there might be something suspect in that relationship, that children should be wary of all adults – unless they're government-approved?"

This move is indicative of a government ideologically compelled to control. It is time that schools were trusted with the care of children, backed up by parents through PTAs and other internally determined processes. Unless power is taken back from the state, we will increasingly see the destruction of the institutions and informal ties that bind people together. Moves such as these undermine further the fabric of society, and the best thing the authors can do in response is ignore the government and carry on attending schools regardless.

Feminism has become just another special interest

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We recently learned from Tim Worstall that the so called gender gap is actually a motherhood gap. But meanwhile. the recession is about to  reverse even that gap. Since men still dominate the construction and manufacturing sectors, which have been hardest-hit by the recession, they are much more likely to lose their jobs than women. This is likely to be true in most Western countries, not only the US, where 80% of the 5.7 million jobs lost between December 2007 and May this year were held by men. Far fewer jobs are expected to be lost in the service sector, especially in public services like healthcare and schools, where women dominate. These sectors even gained 588,000 jobs in the same period in the US.

Therefore, economists are already speaking of a “man-cession" with deep implications to the social fabric of society. It was not only market forces which brought this about. Organized feminist lobbyism played a major role here, manipulating president Obama’s stimulus plan, the $787 billion American Recovery and Reinvestment Act of 2009. Originally his emulation of the 1930’s New Deal aimed to protect jobs in exactly those hardest-hit sectors by investing in “shovel ready" programs to modernize roads, bridges, electric grids and other infrastructure.

Woman’s organizations immediately denounced this as a “Macho Stimulus" and about 600 feminist economists and 1000 feminist historians managed to press the president to scrap his “sexist bailout". The anti-stimulus feminist action group called WEAVE – Women’s Equality Adds Value to the Economy was a huge success. They managed to get the Obama administration to completely rewrite his stimulus along gender-correct lines with 42% of new jobs going to women. Yet since women had only held 20% of the jobs lost in recession the stimulus as it passed through Congress on February 17 skews the creation of new jobs heavily towards women. And its working: the Labor Department’s latest June data revealed a 2.5 percentage-point gender gap for women over men.

Marriage and the welfare state

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There is a rather interesting debate between Peter Hoskin and Fraser Nelson over at the Coffee House blog on the value of Conservative Party plans to use the tax system to encourage the institution of marriage. Following the lead of the Centre for Social Justice, there are plans afoot to encourage marriage via a £20-a-week tax break for married couples.

The exchange can be viewed, here, here and here. With the original post inspired by an excellent article by Philip Collins in The Times. Central to the debate is the efficacy and morality of giving tax breaks to encourage marriage. Peter Hoskin and Philip Collins win the efficacy side of the argument. £20 per week really won’t make much of a difference. This in turn makes Fraser Nelson’s defence of the morality of the scheme mostly redundant. Yet without other reforms the poorest are nevertheless incentivised to stay unmarried or pretend to be apart. However, rather than introduce more incentives to mitigate the unintended consequences of current policies, the Conservatives need to deal with the original government interventions.

This of course involves radical welfare reform as well cutting tax for the poorest. Alongside a flat tax, we at the Adam Smith Institute have long argued for raising the personal allowance to £12,000. With only basic welfare and a fair tax system the effects of welfarism that rightly concern Fraser Nelson and the Centre for Social Justice will be dramatically reduced, without the need to rely upon the state to try (and fail) to correct its own mistakes.

Dealing with debt

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Currently, the public sector is swelling far beyond its means. The UK is forecast to suffer a budget deficit of £170 billion later this year. This equates to every man, woman and child being in nearly £3,000 of debt. Every year, our government pays £200 billion to public sector employees and this is not sustainable. The problem with this is that the increasing deficit needs to be funded somehow.

There are several ways that this can be done. One way would be to increase taxes; however an increase in tax rates reduces incentives and is therefore likely to have the adverse effect of reducing tax revenues. Alternatively, ‘quantative easing’ (glorified printing money) could be used to pay off debt. But this is highly inflationary, as resources are no less scarce, so it would reduce the value of our currency, thus making the UK less attractive for investors.

Surely the best way to deal with the deficit is to reduce government spending. Reducing state funded employment would be a good place to start. Making public sector employees redundant would not totally reduce the burden, as they would then become an added burden to the welfare system through social security. Instead, it would be more effective to incentivise them to join the private sector, become entrepreneurial, set up small businesses, and employ people. This could be carried out through a number of measures. For instance, tax holidays for start-up businesses.

You could also increase firms’ willingness to take on new employees by abolishing national insurance. National insurance is a disincentive for businesses to employ people. It would be far more sensible to remove this tax in its entirety, encouraging businesses to employ more people who will in turn pay income tax themselves. This is likely to generate more government revenue than national insurance did to begin with.

Antisocial policies

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Chris Grayling, Shadow Home Secretary, has given a snippet of the criminal justice strategy to be released by the Tories in the autumn. So far it’s not shaping up to be the most-hard hitting or persuasive of measures to tackle anti-social behaviour amongst young people.
 
The proposal is for the police to be given the power to confiscate bicycles and mobile phone SIM cards for up to a month if a young person is suspected of acting in an anti-social way. This is part of a plan to introduce ‘softer’ measures against teenagers to prevent them committing crimes and to save time and resources administering harsher punishments, such as the infamous ASBO. There are multiple problems with this approach, not least the policy-makers failure to understand the psyche of Britain’s teenagers.
 
This proposal is the latest in a long line of instances where politicians have sought to bypass some of the fundamental rights which we should enjoy as citizens, no matter what age. Police should not be given the jurisdiction to confiscate and punish ‘at their own discretion’. Giving such powers to police will only result in an abuse and overuse of state control over individuals.
 
I can see the logic behind Grayling's idea to confiscate bikes and SIM cards from troublesome youths as an intermediate punishment for lesser offences, but in reality it will never work. The type of young person who acts antisocially is probably not going to be put off by having their bike confiscated, they are just going to steal a new one. And by taking their mobile phones, they will no longer be texting one another from their bedrooms, but meeting in gangs in parks and on street corners. The way for authorities to forge productive and respectful relationships with young people is not by confiscating their property.
 
To tackle antisocial behaviour amongst young people, the Tories will have to attack the root of the problems. First they need to remove the disincentives endemic in the welfare system of modern Britain, rather than blacklisting and demonising them. Most teenagers make up a valuable part of our society, the Tories plans are well intentioned, but show they are still out of touch.

Sir David Walker: A response

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Sir David Walker's report will be widely welcomed as sensible and indeed it does have some good aspects, notably limiting bank directors on the number of boardroom tables they can grace. Unfortunately, the major part is a hollow reannouncement of powers the FSA already has but has shown itself incapable of applying. The FSA can already veto bank director appointments it deems to be wrong but the FSA lacks the skills to distinguish "good" from "bad" appointments as at least one recent appointment testifies. And even if it did have those skills, would it have the muscle to impose that opinion on a united board of a major bank that thought otherwise? Such opinions are subjective and hard to prove in a court of law. And the FSA is run by lawyers.

Eminent as Sir David is, he is part of a system which has resisted all outside calls for major behavioural change so far, with the sole exception of switching short term cash bonuses to long term paper ones. Internally, banks have rediscovered conservatism not because of any government or FSA regulation but because the market has delivered a major shock. The same will apply to the future behaviour of bank directors. Until today's junior managers are taking their pensions, that is.

Re-energizing Britain

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According to our latest reportRe-energizing Britain by Nigel Hawkins – there could be blackouts in Britain unless the government spends less time producing energy policy documents and more time trying to get the six major energy companies to invest.

The UK's energy fate depends upon this sextet, and unless they invest enough in new generation plant, power cuts are not just possible, but probable. But – faced with tougher lending conditions from the banks and better investment opportunities overseas – two of the six are actually cutting back their investment plans.

In particular, the government needs to be more pro-active in driving through planning approvals for new nuclear power stations, and helping the companies put together nuclear investment funds, so that new nuclear plant is ready to fill the gap caused by decommissioning older stations.

The report's author, energy analyst Nigel Hawkins, says that nuclear power should be helped further by replacing the existing Renewables Obligation – which requires electricity suppliers to buy from wind, wave, biomass and other 'green' energy sources – with a new Low Carbon Obligation – which would include nuclear power.

Hawkins says that the three key aims of energy policy – security of supply, reduced carbon emissions, and lower prices – would all benefit from this change, since nuclear energy is both low-carbon and less expensive than many other ways of generating electricity, and does not depend on risky supplies of gas from Russia.

The report also argues that we need fewer words and more action on promoting investment in gas storage, where our capacity is just a tenth of that of Germany. This, it says, is "a very exposed position", since an increasing proportion of our gas now comes from abroad, much of it from Eastern Europe and Central Asia. The government needs to work with the energy companies to make sure that they have both planning approval and access to finance to increase Britain's gas storage facilities substantially.