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I'm aware there was a financial crisis in 2008 and because of that crisis the BoE cut the base rate to very low. For example in 2008 the base rate was 5%, but by 2009 it was 0.5%.

But why did the BoE cut the base rate so low? What were they trying to achieve with the cut?

And then what didn't happen after the base rate was cut that made the BoE feel it must keep rates low for the next decade? I say this because when I look at the base rate history it's always been a lot higher, so I was wondering what had changed in the UK economy that meant the base rate could not return higher.

Things clearly changed after 2020 but that seems to be because of the pandemic and the inflation it caused. The BoE seemed like they were forced into raising the rate rather than actually wanting to do it.

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  • $\begingroup$ Did you do any research so far? I think there are plenty of explanations of you Google. $\endgroup$
    – AKdemy
    Commented Aug 7, 2023 at 15:08
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    $\begingroup$ could you link them??? Because I haven't seen any that specifically answer my question. I've read lots that require a tonne of specialist knowledge I just don't have. $\endgroup$ Commented Aug 7, 2023 at 17:21
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    $\begingroup$ Don't let the downvoters get you down. This is an excellent question and convincing answers are very hard to find. You might benefit from reading Richard Koo's work on "balance sheet recessions". $\endgroup$
    – Mick
    Commented Aug 8, 2023 at 7:46
  • $\begingroup$ @Mick thank you for saying this. I'm new to economics and my questions are just me trying to understand why the central banks make certain decisions. $\endgroup$ Commented Aug 8, 2023 at 8:09

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For short: 2008 was a very severe crisis. Low inflation rates, low inflation expectatations and persistent slow growth did not require higher interest rates.

There were likely other forces at play that contributed to this, allowing central banks to keep rates low. For example:

  • Higher savings rates globally from numerous sources drives down market interest rates (China grew a lot and has flooded capital markets with money, ageing population and larger income inequality shifted savings to more affluent people with higher savings rate, more risk aversion and demand for safe assets)
  • Lower growth and less capital intensive industries (railroads vs "a few servers") reduces demand for capital: supply of capital up, while demand down, means lower rates

Ultimately, it really is all about low inflation and sluggish growth. Once inflation goes up, central banks act and raise interest rates.

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    $\begingroup$ This answer is more about why it was possible for banks to keep rates low. I already understand, there is tonnes of commentary on this. My question is about why the BoE felt they couldn't raise the rates back up. $\endgroup$ Commented Aug 8, 2023 at 6:44
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    $\begingroup$ Why would they raise rates if inflation is low and growth sluggish? It would just slow down the economy even further and not help anyone. I assume you know that too and just don't know what you are asking. $\endgroup$
    – AKdemy
    Commented Aug 8, 2023 at 7:18
  • $\begingroup$ So the bank looks at inflation and growth and if that doesn't hit their targets they will try to keep rates low. From my understanding the target for inflation is 2%, is there a specific target for growth? Thanks for your reponse $\endgroup$ Commented Aug 8, 2023 at 7:38
  • $\begingroup$ @troybeckett The growth target is as high as possible under the constraints of their other goals, and as you said, an acceptable rate of inflation is one of them. $\endgroup$
    – H2ONaCl
    Commented Aug 9, 2023 at 5:15
  • $\begingroup$ @H2ONaCl what are the other goals?? Employment $\endgroup$ Commented Aug 10, 2023 at 12:27
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IMHO you will be hard pressed to find a convincing answer in the literature so I'm going to give you my own personal answer.

First thing to note is that bank lending creates money and the repayment of bank loans destroys money. This means that the dynamics of the money supply are the same as the water level in leaky bucket with a tap pouring water into it. The rate of flow of water entering the bucket corresponds to the rate of new money creation from new loans and the rate of water flowing out of the bucket corresponds to the rate of money lost through loan repayments. In the run up to 2008 there was a massive housing bubble where people were borrowing ever larger sums to buy houses incentivised by the prediction that their price would rise. This rate of borrowing was stupidly high and totally unsustainable. In 2008 the bubble burst and the enthusiasm for new loans took a nosedive. So the rate of flow into the bucket slowed to a trickle. Note that mortgages last for decades and so the rate of destruction of money from loan repayments continued at a high rate. Had the central banks done nothing then the money supply would have fallen (leading to all sorts of bad economic consequences). So now the western world had transitioned to a state where for many years to come the governments and or central banks would be battling against this huge hole in the bucket and have to do many things to try and get the water flowing into the bucket. One of the things done was to drop interest rates to near zero to try and encourage lending to reach the previously stupidly high and unsustainable levels they were before 2008. This exact scenario went on in Japan for decades after their housing bubble burst.

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  • $\begingroup$ No one even attempts to answer it in the literature! How does lending for mortgages actually increase money supply?? Don't you use all that money to buy the house, so you can't really spend it. $\endgroup$ Commented Aug 12, 2023 at 10:18
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    $\begingroup$ To understand how new mortgages increase the money supply you could follow the link in the first sentence of the second paragraph or watch this youtube.com/watch?v=CI5CFQXJxcA $\endgroup$
    – Mick
    Commented Aug 12, 2023 at 11:43

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