Unequal growth and the risk of rate rises
Taking the OBR forecasts for growth household debt and other variables as a base case they have looked at the impact of rising interest rates on different household types under several different scenarios.
The Foundation have modelled what happens to debt interest payments as a percentage of disposable income growth under a variety of different outturns – including strong and fairly shared income growth, weak and skewed income growth and interest rates rising by more than the current market forecast.
As Resolution note, under the worse scenario:
The number of families in Britain with perilous levels of debt repayments could more than double to 1.2 million if interest rates rise faster than expected in the next four years and household income growth is weak and uneven.
Of course this worst case scenario may not be likely – as the MPC’s David Miles argued at the launch event today, the circumstances under which income growth is weak and skewed to the top and the Bank hikes rate by 2% more than the market is expecting are hard to envisage. Unless the MPC were to seriously over react to imported inflation, I personally can’t see this happening.
But even the ‘better’ scenarios still offer worrying results and as Resolution argue:
Yet with few able to say with confidence what interest rates will be in 2017, the findings also stress how little freedom for manoeuvre the Governor and Monetary Policy Committee may have if the squeeze on household incomes continues and external factors—or a domestically generated housing boom—generate pressure for higher rates.
To me the key finding is the different impact of raising rates across the income spectrum. The crucial variable here is how evenly the proceeds of growth are shared. And this, I think, poses a challenge to how monetary policy makes think about the economy and the monetary policy transmission mechanism.
The conventional way of thinking is that as growth picks up, rates will need to increase. But what if growth picks up in manner similar to 2003-2008? I.e. what if by 2017 the economy is growing at a decent clip but the gains from that growth are accruing mainly at the top of the income range? If the MPC responded by raising interest rates then the hit on middle and lower income households would be severe as interest costs rose but their incomes did not.
This is not an implausible scenario and it is one that the MPC should consider carefully. It is also another strong argument for seriously thinking about how wages are set in this country and how we can re-establish the link between GDP growth and median incomes.