A trade off for monetary policy

Since the global financial crisis interest rates in the UK (and the US, Europe and Japan) have been at record lows. The aim was to boost Aggregate Demand and avoid prolonged recession and promote faster recovery. An interesting trade-off has been highlighted as a result of this policy.

The low interest rates have indeed maintained UK output, according to a Bank of England economist, but the low rates have meant firms that should have ceased operations have been able to survive. Around 1.5 million jobs have been protected according to Andrew Haldane.

Of course saving jobs was exactly what the Bank of England were trying to do when they lowered rates. The unintended consequence of this action was that it reduced the costs of poorly performing firms. Those who were not efficient enough to earn the profits necessary to repay loans at 'normal' rates of interest have been able to survive ('Zombie firms' according to Haldane).

The impact has been to allow low productivity jobs to survive and this has led to poor improvements in productivity overall, because the productivity figures reported are an average over the whole economy.

Productivity is a measure of efficiency. It records how many inputs are required to produce a given level of output. For economic growth to deliver higher standards of living a rise in productivity year on year is crucial. The UK has a very poor productivity record generally and the low interest rates since 2008 have allowed this to get worse.

Haldane says that he is happy to have seen 1.5 million jobs saved rather than 2% productivity growth. At least 1.5 million people and their families will be agreeing with him.

The BBC article is here

As this is an article about the UK as an example it is directly useful to IB students. However VCE students can see the example of how all policy has trade-offs and policy actions often have unintended consequences, such as supporting inefficiency to reduce unemployment.