Across the world, policy interest rates have been steadily increasing over the past year for the first time in a long while. In the UK, the last time Bank Rate increased by 3 percentage points in a single calendar year – as it did last year – was in 1988. At the same time, many countries are making serious attempts to tackle regional inequality and a growing geography of discontent in lagging regions – a task that has been made more challenging by the pandemic. But what do rising interest rates mean for places?
Winners and losers
Shifts in monetary policy always generate winners and losers. Interest rate rises benefit savers and harm debtors. Central banks have been developing increasingly sophisticated models to better understand how their policies affect different slices of the population.
But it is equally important to understand potential impacts on places. We now know that major monetary policy shifts during the Great Recession affected places very differently: highly indebted areas with a large share of adjustable-rate mortgages that employed a large fraction of people in locally non-tradable sectors (e.g. food outlets) benefitted the most from the sharp falls in interest rates in 2008. Evidence suggests that monetary policy boosted annual employment growth in these regions much more than regions with less favourable mortgage and employment structures.
Cuts in rates in 2008 had a very variable impact on places
The ECB also found sharp spatial differences in impacts of monetary policy decisions, with stronger, longer lasting effects on poorer regions. Their work shows a 100bps rise in interest rates shrinks output in the poorest 10% of regions by 2.5%, compared to 2% for the top decile. This difference may seem small, but more concerningly, while richer regions bounce back from this hit within five years, the poorest regions do not, widening longer term inequalities.
In the current context, with rates rising by 250bps in the Eurozone, 390bps in the UK, and 450bps in the US over the last 18 months, this would imply that poorest regions could be in for a long-term hit to output of between 5-10%, while richer regions adjust relatively quickly.
Has anything changed?
Has anything changed in recent years to suggest that things might be different this time around?
Across the world, the share of adjustable-rate mortgages has fallen in response to rock-bottom interest rates. In Spain, the proportion of adjustable-rate mortgages fell from over 90% before the Great Recession to around a quarter today. In the UK, more than 95% of new borrowers took out a fixed-rate mortgage in 2021.
On the flip side, developments in labour markets could well have increased the potency of local responses to rate rises. For many countries, the share of non-tradable employment has gradually increased over time. For example, non-tradable employment in France increased by 15% between 1999 and 2015. This trend means that local economies today are more likely to amplify the direct effects of mortgage rate pass-through, as a greater share of local employment is reliant on the financial affairs of nearby residents.
The evolution of household debt is a little more nuanced. OECD data shows that in the US and the UK, household indebtedness has fallen since the Great Recession. But in countries like Italy, France, and Canada, it has risen. Either way, there is a good chance that regions that have experienced sustained house price growth over the past decade have become more indebted (especially if local income growth has not caught up).
Left behind?
While much has changed since 2007, there is little to suggest the overall pattern will be different this time. It is likely that recent hikes in interest rates will widen regional inequalities over the longer term, adding to the economic woes of lagging places and potentially fueling perceptions that the system is rigged against them.
Central banks may be powerless to prevent that, given their remits focus squarely on aggregate measures. But governments are not. It is time for them to consider a bold new policy package to show the poorest places they will not be left behind as collateral damage from the global response to recent price shocks.
Read more on the work of the OECD on Regions here.
Fergus Cumming is Chief Economist of the UK Health Security Agency where he leads workstreams related to the interaction between economic and health security. Before that, he worked at the Bank of England for over a decade in the financial stability and monetary analysis directorates. His research spans topics in monetary policy transmission and the role of debt, as well as various issues in public health in recent years. He completed his DPhil in Economics at Nuffield College, Oxford and holds a BSc and MSc from the London School of Economics. He contributes to this blog in a personal capacity.
Andrew Paterson is Senior Counsellor at the OECD Centre for Entrepreneurship, SMEs, Regions and Cities and editor-in-chief of the COGITO blog site. Prior to joining the OECD, he was a senior civil servant in the UK Government where he led the UK Business Productivity Review, identified new emerging technological strengths as a focus for the Government’s Industrial Strategy, and developed the UK’s approach to “levelling up” through local growth. In previous roles he led the UK Government’s Housing, Planning and Local Growth analysis, economic and financial reforms in Britain’s Overseas Territories from the UK Foreign and Commonwealth Office, and neighbourhood renewal and regeneration policy from the UK Treasury. Andrew holds a Masters in Politics, Philosophy and Economics from the University of Oxford.