“Most countries that have been more successful in tackling inflation have used fiscal policy (rather than the monetary policy of raising interest rates) to bring down inflation – involving various forms of price controls.“Andrew Fisher
By Andrew Fisher
The Bank of England has increased interest rates for the 14th consecutive time now, in a bid to bring down inflation.
The theory is that by hiking interest rates you take demand out of the economy, and force people with debts and mortgages to spend a higher proportion of their income on servicing those debts, rather than competing for goods, pushing up prices.
The other, more brutal, part of the theory is that by increasing costs for businesses, they will limit wage increases and/or lay off staff. In turn, workers will be less inclined to ask for higher salaries as they fear for their job.
But the Bank of England’s is the wrong strategy, and badly applied.
Even if you believe there is too much demand in the economy, and raising interest rates is the solution, surely it would be wise to leave them where they are – given their impact at the current level is still yet to be fully felt. After 13 interest rate rises, many people on fixed term mortgages have yet to be hit by any rate rise – the soaring increase when they come to fix their next mortgage will be an extreme shock to household finances.
The problem is not simply that the Bank of England has the wrong strategy or the poor application of that strategy, but that it is only allowed one strategy – raising interest rates – to combat inflation.
Imagine that I’m a handyman and the only tool I’m given is a hammer. My strategy is then to hit things that pop up with the hammer. That’s all well and good if I’m dealing with nails, but it’s a fairly brutal way of dealing with screws.
It may work in the short-term – you may be able to hammer a screw into a wall and hang a picture, but you may have cracked the plaster and it will probably fall down before too long.
The problem is the ‘hammer’ is not the right tool to deal with a screw. And interest rate rises are not the right tool to deal with our current economic situation. Our inflation has not been caused by an overheating economy with high levels of business and consumer confidence, but by constrained supply and unregulated profiteering.
The IMF has said that “rising corporate profits were the largest contributor to Europe’s inflation”, and the European Central Bank has recognised that some sectors have “taken advantage”.
This is why most countries that have been more successful in tackling inflation have used fiscal policy (rather than the monetary policy of raising interest rates) to bring down inflation – involving various forms of price controls.
As the IPPR’s senior economist, Carsten Jung, has argued: “Spain capped energy prices by more than the UK, lowered the cost of public transport, taxed excess profits and put in place limits on how much landlords can raise rents”. Spain has inflation of around 2 per cent. Elsewhere in Europe, France – with publicly owned energy – capped price rises at 4.5% in the year that ours rose here in the UK by 97%. In Germany, the state offered a €49 monthly ticket for all buses and local train services – slashing fares. This not only brought down inflation, it saved low paid workers money and contributed to an increase in public transport use.
The example of Spain and others also highlight the distributional argument against using interest rates to tackle inflation. They have capped profits – of landlords and corporations – while protecting the incomes of those on lower incomes (through reducing the cost of essentials – housing, energy, public transport).
In the UK, we are driving down wages, hiking housing costs and doing nothing to challenge the rampant profiteering by the supermarkets, energy corporations and landlords. Those who are hit by rising interest rates are those in debt. Those who benefit from higher interest rates tend to be those with considerable savings. In short, we are punishing low- and middle-income earners, while giving a bonanza to the wealthiest and profiteering corporations.
This is likely to lead to greater homelessness and poverty – which have already been rising for more than a decade. It may also lead to recession, as consumer demand is sucked out of an already weak economy.
As former shadow Chancellor John McDonnell MP argued: “Yet another interest rate rise by Bank of England highlights the bankruptcy of the political economy of the UK establishment. Forcing a potential recession on an already struggling economy with all the suffering it will cause is reminiscent of 18th century medicine using leeches.”
The blame for this policy failure lies squarely at the door of Government.