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Is the UK becoming like Japan?

19 Jan 2020

New MPC member Gertjan Vlieghe gave a speech yesterday at the London school of Economics, arguing that UK interest rates may stay below the norms of previous rate cycles for years, perhaps decades, similar to the interest rate path in Japan since the 1990s

He argues that structural changes in household and company debt, demographics and income distribution all have a significant outcome on the effect of interest rate moves

Debt - numerous studies show that highly indebted individuals and companies decrease spending much more sharply in response to a downturn, than compared to those with lower debt levels. UK debt to GDP ratio is now 160%, compared to 120% pre-crisis - so a lower increase in rates would now be needed for the same same inflation-dampening effect as previously

Demographics - with an increased dependency ratio now (number of retirees compared to workers), the total level of savings is lower, as retirees tend not to save, but workers do. So, fewer people with higher savings rates (workers) and more people with lower savings rates, means that any increase in rates would not have the same dampening effect as previously - this is the same as having a higher inherent/real interest rate in the economy

Income distribution - UK income/wealth inequality has grown since the financial crisis, similar to many developed countries. A rise in interest rates would likely increase the debt ratio, as households at the lower end of the wealth spectrum would likely take on more debt to maintain consumption, despite weaker income growth.

In short, a highly-indebted economy faces headwinds and needs lower interest rates. UK long term interest rates have been on a similar path to that of Japan in the 1990s, albeit a couple of decades later. Like Japan, short-term rates may stay lower for longer than previously

For the full speech see here

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