Conor here: Richard Murphy examines central banks willing to do their part in helping to accelerate the recession.
By Richard Murphy, Associate Professor of Accounting Practice at Sheffield University Management School and director of Tax Research LLP. Originally published on Funding the Future.
In an article published yesterday in the Financial Times, Megan Greene, a foreign member of the Bank of England’s Monetary Policy Committee, said the UK may need higher interest rates if the war in the Middle East continues and energy prices rise as a result.
What worries him is that the increase in electricity prices may cause what economists call “the effects of the second round of inflation”. In other words, workers may demand higher wages to offset the rising cost of living, and companies may raise prices to protect their profit margins. That combination, he suggests, could create persistent inflation that would require monetary policy intervention from the Bank of England. In other words, he thinks they may need to raise interest rates.
I think you are wrong, and that is dangerous.
The first point to note is that an increase in oil or gas prices does not mean inflation in general. It creates limited price volatility and the resulting economic shocks as people and markets adjust to high-cost energy. That adjustment will undoubtedly make many people poorer because they will have to spend more on energy in the future and have less surplus on other things, demand may decrease as a result, which may affect their prices.
But that is not the same thing as the normal process of inflation caused by excess demand. If so, what Greene is really arguing against is that the Bank of England should deliberately ensure that people cannot protect themselves from this adjustment process which could result in a loss of income. His idea is that if workers receive higher wages to reduce rising electricity costs and businesses are able to pass those labor costs and higher energy costs, the initial shock may spread to the economy. So he says, the interest rate should go up, economic activity should go down, unemployment should go up, and bargaining power should go down, even though there is no real increase in demand in the economy as a result of that happening, and the opposite may be true.
The question is whether it makes sense.
Who Is Responsible?
The first problem with Greene’s argument is that it treats the victims of power shock as if they were somehow responsible for it.
If the war in the Middle East is disrupting the supply of energy, British workers did not cause that problem.
Neither did British pensioners.
And British families did not struggle to repay their loans.
However, Greene’s proposed answer suggests that these groups should bear the responsibility for this price adjustment over which they have no control and no responsibility. That represents an unusual concept of economic justice.
Another would be to recognize that electricity price shocks are distributional events. No doubt someone has to bear the cost, but the real question is who would that be?
If energy companies increase profits, as they may, or if stock traders profit, or if financial markets use volatility, as they probably do, then there is a strong case for intervention to limit those profits, or to tax them.
Likewise, there is a strong case for supporting families whose real income is damaged by events beyond their control.
What is not a strong case is to deliberately cause an economic crisis by raising interest rates with the intention of suppressing wages due to the increase in unemployment in the economy, which is what Greene is proposing.
Evidence From Recent Years
The second problem is that recent information does not support Greene’s confidence in monetary policy.
The Bank of England has raised interest rates sharply from late 2021 due to inflation caused by the temporary supply shock caused by Covid and inflation driven by commodity traders after the start of the war in Ukraine.
Mortgage rates are skyrocketing.
Business investment is weakened.
Economic growth has stalled.
And yet most of the inflation that followed Russia’s invasion of Ukraine would always disappear when energy prices stabilized, as I predicted at the time, and that’s exactly what happened.
Higher interest rates did not create more gas.
They didn’t create much oil.
They never reopened supply chains.
They did not end Putin’s war, as they will now end Trump’s.
What they did was to transfer large sums of money to those wealthy enough to own financial assets while increasing the financial stress experienced by millions of households. That was a policy choice, and it is not at all clear why repeating it now would produce a better result this time.
Real Concerns
However, what I find most revealing in Greene’s discussion is his suggestion that inflation may now be more sensitive because inflation has been above target for the past six years.
There is an interesting twist to this claim. As we know, the Bank of England has repeatedly failed to hit its inflation target, mainly, I would suggest, because it has repeatedly assessed the causes of inflation. It keeps insisting again and again that the inflation will be temporary, and because of that it reacts late, then after that it tightens the policy strongly, and the difficulty is the only result, but since the inflation always passes at will, as history proves that it always happens.
However, it is now being said that because expected inflation may decrease, interest rates should probably rise again. In other words, the solution to the consequences of previous policy failures is the same principle.
Please forgive me if I am not satisfied with that argument.
If the current conflict raises energy prices, the logical response is to identify exactly where inflationary pressures are rising and to address them directly.
That may mean we need useless taxes.
It may mean we need price controls, or even quotas, in some markets.
It may mean that income support for vulnerable families may be needed.
It may also mean that increased public investment is needed to accelerate the transition away from fossil fuel dependence.
All of those options address the source of the problem. High interest rates do not. They simply redistribute the pain.
What Greene’s article shows, then, is that much of today’s central banks are still stuck in a framework that treats unemployment and weak bargaining power as acceptable tools to control inflation. Its solution to any problem is to transfer money to those who can handle it, with less blame for it, and less capacity to handle the consequences.
That is the result of the implicit power assumption of orthodox economics, with its inherent bias towards the well-off. Call it the survival bias of the fattest relative to wealth, if you will.
This orthodoxy, however, has a surprisingly poor track record in the face of asset shocks, energy crises and global instability.
The lesson of recent years is not that interest rates should rise quickly. Instead, the central banks should be very careful about assuming that they can solve all the problems by making the majority of people in the country poor because of their policy decisions, because that is what high interest rates are intended to do on purpose.
The simple truth is that if another power shock comes, impoverishing millions of people is not the answer. It will only add the second problem to the first and compound the shock that the economy will face.
Megan Greene does not offer a solution to our problems. His aim, as well as the Bank’s and the ideas he is working on, is to make everything worse once the crisis has started by imposing more and unnecessary poverty by imposing higher interest rates, which is why, right now, strengthening or eliminating the so-called independent powers of the Bank of England is one of the most important things the government can do. The people of this country really can’t afford Megan Greene and her misguided opinion.
