The Bank of England’s decision to raise interest rates is dangerous and irresponsible
The era of free money may be coming to an end. Major central banks around the world are embarking on a cycle of monetary policy tightening. On Thursday, the Bank of England raised its base interest rate – the rate at which it lends to commercial banks – for the second consecutive time. Just under half of the members of the bank’s monetary policy committee wanted a bigger hike.
This decision was motivated by strong increases in some prices compared to their level last year at this time. The European Central Bank and the Federal Reserve in the United States have signaled that they may follow suit in the coming months, with several increases already “priced in” by the markets.
Low borrowing costs over the past decade had given households, businesses and governments a bit of a reprieve. For households in the UK and around the world, however, it was a decade in which living standards fell. What higher interest rates will now guarantee is that these living standards will continue to fall.
The tightening of monetary policy is not without consequences. When interest rates are raised, the compensating effect on prices translates into higher unemployment, resulting from less credit creation and lower demand for goods and services. Any deflationary results obtained by these policies will come, at least in part, from the suppression of living conditions for workers. Economist Paul Krugman is famous joked that anyone who thought that increasing the money supply would cause inflation without also increasing aggregate demand was convinced of “unsullied inflation”. Similarly, one could say that thinking that tightening the money supply will lead to the opposite results, without further consequences, implies the belief in flawless deflation.
Andrew Bailey, the Governor of the Bank of England, made it clear that these consequences should be borne by workers. The day after the hike, he made unusually blunt remarks when he said “we need to see some moderation in wage increases”. “Now it’s painful,” he added, but that’s what it takes to keep inflation from taking hold.
It’s an old hat. Politicians and central banks often justify destructive anti-inflationary policies by highlighting concerns about the finances of small households and retirees. It is undeniable that the cost of living has risen sharply, driven by the relentless rise in the cost of housing and services. But we have to be careful to understand what politicians and the media have called the “cost of living crisis” in the context of Britain’s long-term economic decline.
Real wages remain below their level before the 2008 financial crisis and the prospects for economic rebalancing in the interests of workers remain bleak. Real after-tax labor incomes (earnings after taxes and adjusted for inflation) are expected to fall another 2% this year and not recover until 2024. The crisis is as much about this shortfall as it is about the rising cost of living . It is not clear that the continuation of wage deflation contributes to solving this problem.
There are, in addition, other ways in which the decision to increase or signal a rate increase is inconsistent. The price increases observed today have nothing to do with excessive wage demands. They are instead led largely by pandemic-induced convulsions in global supply chains and energy markets – themselves the result of decades of endemic corporate greed and monopolization leading to outsourcing and mainstreaming very “just in time” logistics disrupted by the pandemic. Halting price increases due almost exclusively to supply problems by raising interest rates not only shifts the burden onto those least responsible; it is also absurd.
He is similar administration of an antibiotic to fight a viral infection: this will be useless and the patient risks dying.
Beyond these obvious contradictions, it is not even clear that the current price movements constitute “inflation” in any meaningful sense. The movements were too specific, too sectoral. They do not reflect this general decline in the purchasing power of money. They are not motivated by sustained wage increases that affect prices.
It should be remembered that prices are set by companies. And labor costs are only one component of prices. Bailey found it necessary to call on workers to moderate their wage demands, rather than warning companies against the inflationary risk of stabilizing their profits at all costs. Such a request comes after a decade of tolerance for rapid asset price inflation, driven in part by the bank’s policies. The message seems clear: price controls are good, but only for labour. The governor’s comments therefore seem to indicate that the objective of monetary tightening was not simply to ensure the credibility of the central bank, but discipline in the workplace.
The upsurge in monetary firming will have other repercussions. When monetary policy was still ultra-loose following the Great Recession, borrowing costs for government, businesses and households fell. The results were more debt, both in absolute and relative terms. As things stand in 2022, the stock of global debt is estimated to be around $295 trillion, or roughly 355 percent of global GDP.
The global interest bill is around $10.2 trillion. It is difficult to assess the impact of constantly higher interest payments; it depends on the share of debt with a fixed interest rate and the length of the average maturity of these debts. But in Britain 25% of mortgage debt is variable, while in countries like Norway the share is twice as high.
Rarely does a concerted global tightening cycle fail to induce a recession. In this case, it could stifle an already muted recovery. Outside the United States – which managed to enact a massive fiscal stimulus – growth has been tepid and unstable, with demand held back by stagnating household incomes and supply still constrained by tangled supply chains. All in all, now is not the time to abandon low rates.
The call for wage moderation is at odds with the stated policy of Boris Johnson’s Conservative government, which has promised a “high-wage, high-growth” economy. Meanwhile, the highest layers of finance capital have called for inflation-fighting restraint, with two executives at asset management giant BlackRock expressing concern over a premature tightening in the pages of the FinancialTimes. With their plans, central banks are therefore placing themselves in a strange position: well to the right of politicians and asset managers generally opposed to inflation.
Economist Dario Perkins wryly remark“We should have a race. The first central bank to crush its economy with rate hikes wins a prize. Britain seems to have given itself a head start.