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Saturday, 15 January 2011

Back to economics 101

Amongst the first things you will have learned during elementary economics is the difference between real and nominal interest rates. If inflation is 5% and you're getting 6% interest on your savings, the real interest is a measly 1%. If inflation is 5% and you're getting 2.5%, you're losing money and would be better off taking your money out of the bank and spending it on something. The forthcoming rise in interest rates is being trumpeted as 'good news for savers'. Unless inflation falls, of course, it will be nothing of the sort. 

At the top end, 'smart' money can invest in fine wines or art to beat inflation, but what for Mr Ordinary? Property used to offer a safe bet, but predictions are now for a further 10% fall from current values over the next 12 months. With inflation at 5%, that's a 15% drop in real asset value. 

A rise in interest rates will also be the catalyst for earnings growth. Wage rises have been held down for the past two years (except for the fat cats at the top, who saw their wedge rise by 55% last year) as the interest rate has lingered near zero, but this won't continue. The only thing the government can do to forestall wage inflation is to cut tax. And this is the bold stroke I urge upon the Cameron government; a full 3% cut in employee's NI and a 2% cut in employer's contributions from April. If Cameron dithers, he's inviting a perfect political Hell for the coalition in 2011, with high and rising unemployment, repossessions, bankruptcies and commercial property joining residential in a nosedive. Does he have the balls?

1 comment:

Anonymous said...

Good article in Telegraph.
One poster makes the rather cynical claim that "Osbourne is going to destroy growth over the next 3 years and use rising unemployment to hold wages down so interest rates can be held down artificially.

He'll reflate for the 2015 election and with 6% real RPI, he will have achieved a 20% or so real reduction in debt values, the cost being a massive reduction of spending power for real goods."