The Quantity Theory of money states that the central bank, which controls the money supply, has the ultimate control over the rate of inflation. If the central bank keeps the money supply stable, then the price level will be stable. If the central bank increases the money supply rapidly, the price level will rise rapidly. Following QE, it would be good if the Bank of England’s recent Inflation Report had given some indication of the state of things but it only seemed to confirm that nobody really knows what is happening.
Real Interest Rate is the rate of interest before adjustments for inflation. With the current inflation rate at 2.9% ( target of 2%) and current Bank of England Base Rate at 0.5% , Real Interest is currently 2.4%. Unless the low interest rates create inflation we’re looking at a longer period of such rates. However it must be remembered these low rates are not Commercial Bank Rates and the concern remains that recovery is prohibited without Commercial Banks cooperating with lending and saving.
By definition the changes in prices are inflation, inflation affects the interest rate and the interest rate affects demand…. and in between there are some complicated equations to get to the results but essentially the Bank of England says that the UK recovery is likely to be slow and protracted; which translates as they just don’t know where the trinkets are and when they’ll start to sparkle.
Back to business then…..