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.
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.
As someone who's likely getting pinched by this, I agree. Interest rates are too much of a blunt instrument.
I've recently bought a house, after renting for 20 years. I've seen miserable savings growth for most of that - whilst house prices have run rampant, on low mortgage rates.
And now, finally... well, I couldn't continue to rent for another decade, and a house was finally in reach.
So my savings are gone, just in time for the interest rates on _those_ to spike, and my mortgage isn't 2% but now 5%, and liable to go up.
It's actually higher than my rent was, because my landlord was - probably - technically under pricing, due to having 15 year old mortgage on a house that's more than doubled in value since. I certainly couldn't have afforded to buy them out at the 'market value'.
... but now of course, I think it likely that house prices will start to drop off again, because I am still pretty sure that that's the biggest impact of interest rates - that initial affordability.
Pinching people with mortgages (which includes me now admittedly) to 'slow down inflation' I don't think is going to do anything much. And pinching renters - because rent price _does_ track 'mortgage price' albeit with some time lag - isn't going to help either.
A decade of wage repression says to me quite clearly that "disposable income" is not the problem here, and reducing it won't fix anything.
But I guess it might make a few people homeless, and force a few 'unaffordable' house sales, which _might_ push prices down a bit... but only as long as the people who didn't 'cash in' on the good times, don't see it as an opportunity to become a landlord at a discount price.
The house market in this country is broken, and the repeated cycles of 'fuel on the fire' haven't helped. But now it's too late - now the next generation are carrying the can for the previous one's prosperity. Anyone who's bought a house in the last decade or so 'bought in' at a high price, and now is going to get screwed. (Anyone renting is too, for almost the same reasons).
Consecutive interest rate rises are a blunt instrument, and don't really solve the problem.
Arguably we _should_ be about this rate of interest, but it should have taken more like a decade to ramp it back up again, because of how long we were riding the wave of 'near zero'.
I contend that 'inflation' right now is down to a bunch of different factors - my money's on a mix of Brexit, Covid (and furlough) and energy price/supply disruption.
But none of those are addressed at all by hiking interest rates.
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.
😁AAV’s article doesn’t convince me that he knows best. I’ll monitor the predicted marked fall this year.
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.
As someone who's likely getting pinched by this, I agree. Interest rates are too much of a blunt instrument.
I've recently bought a house, after renting for 20 years. I've seen miserable savings growth for most of that - whilst house prices have run rampant, on low mortgage rates.
And now, finally... well, I couldn't continue to rent for another decade, and a house was finally in reach.
So my savings are gone, just in time for the interest rates on _those_ to spike, and my mortgage isn't 2% but now 5%, and liable to go up.
It's actually higher than my rent was, because my landlord was - probably - technically under pricing, due to having 15 year old mortgage on a house that's more than doubled in value since. I certainly couldn't have afforded to buy them out at the 'market value'.
... but now of course, I think it likely that house prices will start to drop off again, because I am still pretty sure that that's the biggest impact of interest rates - that initial affordability.
Pinching people with mortgages (which includes me now admittedly) to 'slow down inflation' I don't think is going to do anything much. And pinching renters - because rent price _does_ track 'mortgage price' albeit with some time lag - isn't going to help either.
A decade of wage repression says to me quite clearly that "disposable income" is not the problem here, and reducing it won't fix anything.
But I guess it might make a few people homeless, and force a few 'unaffordable' house sales, which _might_ push prices down a bit... but only as long as the people who didn't 'cash in' on the good times, don't see it as an opportunity to become a landlord at a discount price.
The house market in this country is broken, and the repeated cycles of 'fuel on the fire' haven't helped. But now it's too late - now the next generation are carrying the can for the previous one's prosperity. Anyone who's bought a house in the last decade or so 'bought in' at a high price, and now is going to get screwed. (Anyone renting is too, for almost the same reasons).
Consecutive interest rate rises are a blunt instrument, and don't really solve the problem.
Arguably we _should_ be about this rate of interest, but it should have taken more like a decade to ramp it back up again, because of how long we were riding the wave of 'near zero'.
I contend that 'inflation' right now is down to a bunch of different factors - my money's on a mix of Brexit, Covid (and furlough) and energy price/supply disruption.
But none of those are addressed at all by hiking interest rates.
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.