So, the European Central Bank has raised rates to their highest ever level in the EU. Meanwhile the Federal Bank in the US paused their regular rate increases this week and with some relief for mortgage payers in the UK, yesterday the Bank of England held rates at 5.25%, the first time in fourteen months rates didn’t increase. So what’s going on? Well Keynesian economics are in play. The actions of central banks, such as the Bank of England, are closely related when it comes to the management of interest rates and overall economic policy, writes David Little, a partner in our Corporate & Commercial Law team.
John Maynard Keynes was one of the most influential economists of the 20th century, he produced writings that are the basis for the school of thought known as Keynesian economics, and are still fundamental to mainstream macroeconomics today.
Keynesian economics is the macroeconomic theory that emphasises the role of government intervention in the economy, particularly during times of economic downturns, to stabilise and stimulate economic growth. The management of interest rates is one of the tools that central banks use to implement Keynesian policies.
Keynesian economics advocates for countercyclical policies, meaning that during economic downturns (recessions), the government and central banks should implement expansionary policies to boost aggregate demand and stimulate economic activity. Lowering interest rates is one of the primary tools used to achieve this goal. When the economy is struggling, the Bank of England may lower interest rates to make borrowing cheaper, encourage spending, and stimulate investment.
Keynesian economics also emphasises coordination between fiscal (government spending and taxation) and monetary (central bank interest rate) policies. In practice, this means that the Bank of England may coordinate its interest rate decisions with government fiscal policy to achieve desired economic outcomes. For example, if the government implements fiscal stimulus (increased government spending) during a recession, the central bank might complement this by lowering interest rates to further stimulate borrowing and investment.
Many central banks, including the Bank of England, use inflation targeting as a key policy objective. Keynesian economics acknowledges that some level of inflation can be beneficial for economic stability. Central banks often use interest rate adjustments to maintain inflation within a target range. If inflation is below the target, the central bank may lower interest rates to stimulate spending and raise inflation.
Keynesian economics also emphasises the goal of achieving full employment in the economy. Lowering interest rates can encourage businesses to invest and create jobs, which aligns with this objective.
While Keynes’ theory provides a framework for understanding how government and central bank policies can influence economic activity, the actual implementation of these policies can vary based on the specific economic conditions and the preferences of policymakers. Additionally, there are different schools of thought within economics, and not all economists or policymakers may strictly adhere to Keynesian principles in all situations. Economic policy is often a blend of various theories and approaches, depending on the circumstances. Just ask the Chancellor. Jeremy Hunt has already started managing the Conservative party’s expectations that taxes will be cut in the Autumn statement. Lowering inflation remains his number one goal. So there will be no tax cuts. Tough medicine indeed.
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David Little is a Partner at Bishop & Sewell in our expert Corporate & Commercial team. If you would like to contact him, please quote Ref CB422 on either 07968 027343 / 020 7631 4141 or email firstname.lastname@example.org.
The above is accurate as at 22 September 2023. The information above may be subject to change.
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.