Impotently tinkering with interest rates won't solve anything
BoE interest rate rises are not working. The way to combat inflation is through direct market intervention, but they don't have the power to do what's needed, and the Tory government doesn't want to.
The Bank of England Monetary Policy Committee is spectacularly failing to achieve their stated target of keeping inflation below 2% because their policy of repeatedly hiking interest rates simply isn’t working.
Let’s put aside the fact that setting arbitrary and inflexible targets like 2% inflation makes for bad economics, and accept the target for what it is.
The inflation crisis is bad, and aiming to get it down to a lower level is the right thing to do. Whether the target is 1%, 2%, 3%, or variable according to the circumstances, it doesn’t matter all that much, because any lowering of the rate would represent an improvement on the current inflation crisis.
The problem of course is that the Bank of England’s 14th successive interest rate rise from 5.00% to 5.25% is going to be just as ineffective as any of their other rate hikes, because the problem isn’t being caused by not enough returns on investment, or insufficient costs of borrowing, it’s being caused by private profiteering.
British Gas just announced half year profits of £969 million, up from £98 million for the same period last year. The French state energy company EdF announced £2 billion in profits from their UK operations for the same period. Scottish Power ripped £556 million in profits out of Britain’s absurd shambles of an energy market in the same six month period.
Supermarkets, banks, and online retailers have also been raking in extreme profits, while landlords have been opportunistically cashing in on the inflation crisis too by driving up rents.
With rampant profiteering like this going on, it’s ludicrous to imagine that increasing the Bank of England base rate by a quarter of a point is going to do anything except make mortgages and debts harder to service, pushing more households and small businesses into default and bankruptcy.
The problem is that the Bank of England Monetary Policy Committee know something needs to be done to get inflation down, but they don’t have the tools.
They only have the ability to alter monetary policy, when it’s fiscal policies that are controlled by the government that would actually be effective.
Instead of combating inflation, the Tory government seems happy to let it burn away the value of our money, and then use their own inflation crisis as an excuse to push the same old Tory agenda of austerity, wage repression, infrastructure underinvestment, vandalism of the social safety net, and underfunding of public services, which is an agenda they’ll continue pushing whatever the economic circumstances.
The Bank of England only really has tinkering with interest rates at their disposal (their powers of money creation would only exacerbate inflation), so they’re trying what they already know to be ineffective because they’d rather be seen to be doing something than nothing, even if it’s pretty much pointless.
We know that direct market intervention is the way to get inflation down because we have the Spanish case study to look at.
Spain has the same interest rate as other EU economies like Germany because they’re part of the Eurozone, but they’ve done a much better job of getting inflation under control than any of the other major European economies, and they’ve done it through fiscal policy and direct market interventions to bring prices down.
Instead of throwing £37 billion in public cash at the energy companies to maintain sky high prices and obscene profits like Rishi Sunak did, the Spanish government directly capped energy price rises. They also made regional transport free; controlled the price of staple foods; introduced taxes on excessive profits; controlled rent increases; and cut taxes on petrol and diesel at the peak of the inflation period.
The outcome of these fiscal anti-inflationary policies is that in June inflation dropped to 1.6% in Spain, while it still remained much higher in other European economies with exactly the same ECB interest rates: France 5.3%, Netherlands 6.4%, Italy 6.7%, Germany 6.8%, Poland 11.0%.
We’ve got the perfect case study showing us what needs to be done, but the Bank of England doesn’t have the power to do any of this stuff, and direct market interventions to get inflation down are against the radical-right economic ideology of Rishi Sunak and his government.
As far as Sunak and his mob are concerned it’s great that profiteering corporations are recording obscene profits, and it’s great that workers’ wages are being eroded by below-inflation pay offers.
Why on earth would anyone even expect them to change what’s the culmination of the massive upwards transfer of wealth they’ve been administering since the Lib-Dems enabled them back into power in 2010?
So it seems like we’ll just have to keep watching the Bank of England impotently tinkering with interest rates, more in hope than expectation, while the government steadfastly refuses to do what’s needed to alleviate the soaring cost of living.
Very good article. The BoE's actions are entirely performative. This is a supply side inflation although the elites are desperate to convince the public that it is due to excessive pay settlements. A quick look at the ONS data on average wage growth for the last decade shows what utter garbage this is. It takes approx 18 months for the effect of a change in the base rate to feed through the monetary transmission mechanism. Hence, the reduction in the rate of growth of prices we're currently experiencing is from some of the earliest rises in the base rate. On this pathway, deflation will likely become an issue around the end of 2024 / start of 2025, unless an expansionary fiscal policy is applied.
This rate rise, like all previous rate rises, will only serve to prolong the inflation problem. This is because as well as it increasing the interest on household debt it also increases the interest on business debt. Firms with few competitors or with strong brand loyalty will look to pass this cost on to consumers, thus pushing up the cost of the basket of goods used by the ONS to calculate inflation. So odd why the governor of the BoE never mentions this.
Let's get to the heart of what's going on. This period of contractionary monetary policy is about one thing, wresting back wage bargaining power from workers. The departure of a sizeable number of older workers from the labour force during the pandemic combined with the restrictions on immigration due to Brexit have created a tight labour market. This transfers the balance of wage bargaining power to employees and reduces employers' profits, therefore shareholder dividends. In short, using higher interest rates to kill off demand is a well worn path to creating a pool of unemployed labour that employers can then use to discipline the wage demands of employees via intimidation and coercion. Consequently, a disproportionate share of the firms revenue can be directed to those who put very little, if any, effort into its creation.
Interest rates are definitely the wrong lever to be pulling at the moment because this inflation is driven by shortages of goods and labour. And to my mind that is really the problem. It makes profiteering possible and I think the government should be taxing excess profits especially in oil and gas. Some of those shortages are due to war and drought and out of government control but they could be pushing harder to resolve the delays at the border caused by Brexit. Shortages of Labour do drive up wages which is good for the low paid but to bring inflation down relaxing immigration controls might be a good thing. Direct control of prices tends to lead to problems by creating shortages in the future.