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		The economic naiveté of Gordon Brown Sunday, 7th December 2008 For a man who acquired a certain reputation as a Chancellor, at least during the good times, Gordon Brown shows an extraordinary ignorance of economics. He (and large sections of the media) urge the banks to pass on to borrowers in full the Bank of England’s recent Base Rate cuts. There are two implicit assumptions here: first that this will put money in folks’ pockets, get the tills ringing and rescue the economy from recession. Second, that the banks have a moral obligation to pass on the cuts, and are simply wicked profiteers if they fail to do so. Wrong on both counts. Brown seems to have ignored the fact that lower rates for borrowers mean lower rates for savers. There are more savers than borrowers, and they tend to be older people. Older people may well depend on interest income to live on. They are also more likely to vote, and right now they are acutely worried about low interests rates on their savings. But if the extra pound in the pocket of borrowers is taken from the wallet of savers who relied on the income, we’re looking at a more-or-less zero-sum game. Lower interest rates will not increase spending, nor boost the economy as Brown expects. Nor is it obvious or morally right that the banks should pass on the full rate reduction. First of all, it was excessive lending and borrowing that got us into this mess to start with. There is no logic in asking the banks to be more responsible lenders, and in the same breath to tell them to lend at least as much as last year. Secondly, with the effective collapse of wholesale money markets, banks rely more than ever on retail depositors for funds. They compete in the market for savings. They need to offer attractive rates to savers, and that precludes them from offering aggressive cuts to borrowers. And to the extent that banks can still borrow at all in the money markets, they are paying not Bank Rate, but Libor. On the day that Bank rate came down 1%, Libor fell only 0.3%. Then consider that following the crisis of sub-prime mortgages and toxic debt, the banks, like it or not, have severely weakened balance sheets. It is in everyone’s interests that the banks should strengthen their balance sheets. And the primary way to do that is to operate profitably, which is likely to mean operating on higher margins. Even where the government (and we tax-payers) hold large numbers of bank shares, the government has told the banks to operate commercially, and at arm’s length. It is no good Gordon Brown hectoring and blaming them when they do what he told them, and make rational economic decisions. With its ban on dividend payments in banks it has subsidised, the government, quite intentionally, has given the banks very strong incentives to pay back government funds as soon as possible, so as to be able to resume normal dividend payments (on which many of our pension funds depend). So the government has created an intentional and explicit objective for the banks to maximise profit — increasing the pressure to widen margins. There is no possible point in the government creating incentives for the bank to behave in a certain way, and then kicking them when they do. But we can’t expect economic wisdom and judgement from this government. Very soon they will be attacking retailers for failing to pass on their trivial VAT reduction. Of course they will fail to notice that the costs to many retailers of changing pricing and reprinting catalogues may well be greater than the VAT reduction itself.