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    An Interesting Theory -Why Interest Rates are Important but not for the Reasons Commonly Assumed
    An Interesting Theory -Why Interest Rates are Important but not for the Reasons Commonly Assumed
    An Interesting Theory -Why Interest Rates are Important but not for the Reasons Commonly Assumed
    Ebook90 pages1 hour

    An Interesting Theory -Why Interest Rates are Important but not for the Reasons Commonly Assumed

    By Artie Lees

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    About this ebook

    At the heart of modern economic theory is the concept of interest rates being used to control the economy by striking a balance between growth and inflation. It is a concept that is so well entrenched that few would challenge its validity but when the policy is matched against outcome its track record is disappointing to say the least. Low interest rate policy has failed to stimulate the post-crash economies of Japan and Europe and the marginal success in the UK and USA has more to do with Quantitative easing. This is not its only failure when high interest rates were used to squeeze out inflation in 1980's Britain it remained stubbornly high. As a theory it is not fit for purpose and we should be looking for alternatives.
    An Interesting Theory presents one alternative. In this book inflation, growth and interest rates are still linked but not as commonly assumed. Not by balancing the two but rather as a means of controlling the money supply that in turn has a knock on effect on both growth and inflation. This simple notion can be used to explain why cheap money policies have not worked in Europe or Japan and the failure of that monetarist experiment in Britain along with underlying inflation, stagnation, hyperinflation, bubbles and the success of forward guidance.
    The arguments made here will be considered counter-intuitive to students of mainstream economics and the danger is that they may be so revolutionary that it is considered just another crank theory. However it fits the data so well that they even provide an explanation as to why the current monetary tools including the Monetary Exchange Mechanism work in the short term.

    LanguageEnglish
    PublisherArtie Lees
    Release dateNov 1, 2015
    ISBN9781310842948
    An Interesting Theory -Why Interest Rates are Important but not for the Reasons Commonly Assumed
    Author

    Artie Lees

    Artie Lees is an engineer who spent several years working in the Asia Pacific region. He now lives near London with his family. Comments on this work can be sent via the website www.wealthcreationandwealthdestruction.com

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      Book preview

      An Interesting Theory -Why Interest Rates are Important but not for the Reasons Commonly Assumed - Artie Lees

      An Interesting Theory

      Why Interest Rates are Important- but not for the Reasons Commonly Assumed

      By Artie Lees

      Copyright 2015 Artie Lees

      Smashwords Edition

      Smashwords Edition, License Notes Thank you for downloading this ebook. This book remains the copyrighted property of the author, and may not be redistributed to others for commercial or non-commercial purposes. If you enjoyed this book, please encourage your friends to download their own copy from their favourite authorized retailer. Thank you for your support.

      Table of Contents

      List of Figures

      Introduction

      Chapter 1-Money supply

      An alternative explanation for the growth in the money supply

      Pegged Currency's and the Gold Standard

      Money supply in practice

      Chapter 2 - Growth and Inflation

      Growth and Inflation

      The apparent success of the Monetary Exchange Mechanism

      Inflation -Disease or Symptom

      Chapter 3- The economic consequences in a changing world

      The Form of Money

      Price or Asset Inflation

      Housing Bubbles and Unstainable Lending

      Sustainable Lending and Growth

      Summary and Conclusions

      Footnotes

      Appendix

      Data source for charts

      Hyperinflation

      About the Author

      List of Figures

      Fig 1.1 M4 and money supply growth by interest payments

      Fig 1.2 Pound Sterling M4 compared to total accumulated interest

      Fig 1.3 US Dollar M2 compared to total accumulated interest

      Fig 1.4 Euro zone M1 compared to total accumulated interest

      Fig 1.5 UK Money 1870-1914 and accumulated interest

      Fig 2.1 Comparison of annualised UK GDP excluding inflationary effects and money in the real Economy

      Fig 2.2 Comparison of UK quarterly GDP excluding inflationary effects and money in the real economy

      Fig 2.3 Comparison of UK quarterly GDP and money in the real economy

      Fig 2.4 Comparison of UK Change to money in the real economy and changes to government spending

      Fig 2.5 Comparison of UK Change to money in the real economy and changes to saving and interest created money

      Fig 2.6 UK money supply growth and GDP (Annual change)

      Fig 2.7 Comparison of UK Inflation with the Nominal Lending Interest rate

      Fig 2.8 Comparison of UK Inflation with the percentage change interest repayments on secured lending

      Fig 2.9 Comparison of non-property lending with the Real Interest Rate

      Fig 2.10 Comparison of UK Inflation with the sum of inflation components

      Fig 2.11 Comparison of UK Inflation with real Interest Rate

      Fig 3.1 Comparison of UK Inflation with the sum of inflation components and house price inflation

      Fig 3.2 Comparison of US Inflation with S&P500 P/E ratio

      Introduction

      The principals of today's economic theory have been developed over a number of years and draws from a number of traditions. However at its core is the notion of balancing growth and inflation through the cost of money. This theory seems to work well enough when economies are in good health but has proved unreliable in the years following the 2008 crash. Some put this breakdown to an anomaly but as the same circumstances arose following Japan's crash some two decades earlier it would suggest that there are more fundamental issues at play. This appears to be a total misunderstanding of the role of interest rates in a modern economy. This should not be too much of a surprise when even central bankers confess that they do not fully understand the process as the former Governor of the Bank of England, Mervyn King, has admitted as much¹.

      At the heart of this misunderstanding is how fiat money is created. Traditionally it has been supposed that it was purely down to public demand for borrowing from high street banks that in turn could facilitate them from the central bank which can ultimately draw from an endless stock of government bonds. Whilst this may remain a mechanism during periods of exuberance or hyperinflation further analysis of the data suggests that in more normal times the banks' lending decisions are much more conservative. That they limit any increase in lending to an increase in deposits which grow at a rate similar to the interest charged.

      This in itself offers an explanation as to why the low interest policies recently deployed have not led to the expected growth but it does not explain the corundum of inflation. Previous theorisers may be forgiven for thinking that raising interest rates does reduce inflation because it does but the effects are relatively short term and have remained hidden as governments or central bankers have tried to micro manage the economy. Nevertheless recognition of the relationship between interest rates and inflation goes back to 1930 when Irving Fisher developed the equation that linked nominal interest with real interest and inflation. Fisher and those that followed him drew the conclusion that interest rates somehow predicted inflation rather than the cause it. This is again is understandable because at that time the world was on the Gold Standard when the quantity of money was supposedly fixed. Once more an analysis of more recent data suggests otherwise. This shows that the ratio of inflation to growth is very similar to the ratio of lending on property to the whole suggesting that mortgages are the root cause of underlying inflation.

      This book presents the evidence for both of these observations and suggests mechanisms to explain them. From this starting point comes a new understanding of macroeconomics that not only explains some of the forms of inflation,

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