I posted this thread on Twitter this morning:
We face a cost of living crisis created by events outside the UK triggering rates of inflation that many in this country have never witnessed before. In the face of these rising prices the Bank of England has, inexplicably, increased the price of money itself. This is bizarre. A thread……
For reasons that are very hard to explain, the Bank of England, which is wholly owned and controlled by the UK government, is claimed to be independent of it. That is not true.
The law that supposedly established this independent status (The Bank of England Act, 1998) did not do so. It contained a clause that always permitted the government to overrule the Bank. As a result the Bank always does what the government wants.
What the Bank has, in that case, done for the government over the last eighteen months or so is massively increase the cost of money in the UK. They did this by increasing the base interest rate set by the Bank from 0.1% to 4.5%.
This rate is expected to rise further this week. A rate of 4.75% is most likely come Thursday. It is thought the rate will now reach 5%, or more.
The interest rate increases that the Bank has put in place are intended to achieve one purpose. That is to reduce the spending power of people in the UK. That is because the Bank (and government) believe that people in this country have too much money to spend.
This belief is based on theories on the cause of inflation developed in the 1970s. It was presumed then that inflation was caused by wages rising faster than prices. The excess spending power that this created then dragged prices in its wake, resulting in inflation.
Whether this actually happened in the 1970s is open to debate. What is clear is that, excepting the case of a minority of quite wealthy and high-earning people in this country, this situation does not exist today.
Evidence is very clear that, again excepting the case of a minority of quite wealthy and high-earning people in this country, real pay has for most people in this country been stagnant for a long time, whilst for public sector workers it has been in free fall.
So, again excepting the wealthy and high earners, pay in this country has not and as a matter of fact could not have driven inflation, and nor can it do so for a long time to come because most wage earners have neither the income or savings to force prices up.
So why have we got inflation? The answer is that we reopened after Covid too quickly, resulting in those with wealth seeking to spend on high-ticket items when supply chains to the UK and within it were disrupted.
That pushed prices for some goods and services up for a while. Cars were impacted heavily. So was the cost of new kitchens and building work in general. That situation is, however, now long gone.
In the place of this short-term, and entirely self-correcting inflation, there has come inflation from another source. That is the inflation that has come as a result of war in Ukraine.
But, again, and quite remarkably, most of that inflation has now gone. Wholesale food and shipping prices have now returned to pre-war levels. Gas and petrol prices have fallen drastically from their peak. The underlying causes of price war-based rises have now gone.
But inflation has not. There must be other reasons for that. There are, actually, three.
The first is Brexit. It has created continuing supply chain disruptions and has imposed considerable extra costs that are fuelling continued inflation. This fact cannot be avoided.
Second, there is profiteering. Banks, oil companies and many companies in food supply chains are very clearly increasing their absolute levels of profit, and their profit rates. This is not true for all companies, but it is for many.
The third reason for inflation is that the Bank of England has pushed up the cost of money, and is clearly intent on continuing to do so. This is seriously inflationary, in itself. That needs explanation.
The Bank of England pushes up the interest rate in an attempt to reduce the demand for goods and services. Its logic is that if borrowers pay more in interest cost they will have less to spend. That means demand in the economy should fall, and so, it thinks, should prices.
There are some massive assumptions in that logic. The first is that most people are borrowers. In other words, sufficient people are impacted for demand to fall enough. This is not necessarily true: fewer younger people have mortgages now, for example.
Second, they assume interest costs are not themselves reflected in inflation calculations, but that's wrong. A lot of borrowing costs are now hidden in other price. Take the cost of car rental contracts as an example. 90% of cars are leased, and that cost is in inflation.
Third, rent is a massive cost for many people. In the 1970s it is unlikely that this was insignificant. But now rent is 40% of the cost of living of renters in London. And rent paid is heavily related to interest costs: landlords pass their costs on. Interest is inflationary, then.
Fourth, landlords are not alone in passing on interest costs. Many businesses are financed by debt and pay a lot in interest. The bank seems to assume markets set prices and so businesses can't pass their costs one, but large ones (most especially) can, and do.
In that case, increases in interest are inflationary, yet again.
And let's not pretend that people who have their disposable income pushed down don't try to recover that lost income. We know that they do, even if the Bank of England has been quite clear in their instruction to them not to do so.
And employers then pass on wage rises, even if (as in most cases) the increase in wage costs is less than the inflation rate reflected in business prices. So, interest rate increases reinforce inflation, yet again.
And then we shouldn't forget that some people are made better off by interest rate rises. Many savers see their income go up as a result, and most of them will not be borrowers. So they have more to spend as a result of the Bank's actions.
What is more, because savers also have money in reserve they can dig into those funds to pay increased prices if they still want to spend - and because of their increased income, plus the expectation that prices will only increase if they don't do so now - that's what they do.
I could keep going. My point is that all the assumptions that the Bank makes on the impact of interest rate rises appear to be based on what economics text books say, and the relationship between economics textbooks and reality ceased a long time ago.
It is my suggestion that the Bank of England has not only got their assumptions wrong, they are so blinkered that they cannot see that it is their own interest rate rises that are now stopping inflation falling by creating an upward inflationary cycle.
And we do know the Bank has got their assumptions wrong. They have, for example, already had to abandon their models for forecasting inflation because, as they have admitted, they simply do not work.
Getting your model wrong is one thing. Getting your policy wrong is something else when that policy has real-world implications and they are the opposite of what you intend. That, I suggest is what is happening right now. Interest rate rises are creating inflation.
This would not matter if everyone (businesses, households and international economies) suffered inflation at the same rate. But they don't. Inflation is making most people in the UK poorer right now, and some a lot richer. And it is making us poorer compared to other countries.
The Bank of England is, then, undertaking a massive redistribution of income and wealth right now at cost to those on lower incomes. But also the country as a whole. And this matters as well.
Let me just deal with the income impacts. When those without savings and who borrow see their incomes fall the Bank of England is right: they do eventually spend less. They have no choice. They pay the essentials and hope to survive.
What they cut out are the fun things in life. The trouble is that going out, buying a beer, dressing up and so on all create lots of employment. All of that is under threat. And so even those not feeling the direct impact of borrowing costs see their incomes under threat.
This is a doom loop spiral that in economics is called a multiplier effect. In the macroeconomy if a person saves then someone else does not get as much income as they hoped for, so they too save, and on the process goes. The impact can be big. It creates recessions.
And this downward doom loop multiplier effect amongst those with lower income is not compensated for by those with larger incomes. Although they might have more income as a result of growing interest rates they save some of it. It's because they save that they are wealthy.
What that means is that the wealthy might spend more but they do not spend enough to compensate for the downward spiral those on lower incomes create.
That means that the Bank of England gets its wish: if it keeps increasing interest rates it will eventually get the recession it desires. And let's not pretend there is any surprise in this: the Bank has always wanted a recession to control inflation.
In straightforward terms then, the economic problems that we now face are, at the very least, being partly created by Bank of England policy. I think that they are mainly created by it.
Because the Bank to have never understood that interest rate rises would never address the inflation we got from 2021 but did them anyway, we now have continuing inflation precisely because the Bank has increased the price of money by raising the official interest rate.
If you want to know why inflation is now stubbornly high in the UK, that is the answer. And the response from the Bank of England will be to raise the rate still further. That will mean things cannot get better. It's as straightforward as that.
What, then, should the Bank be doing? I suggest four things. First, it should tomorrow announce no rate increase. It should say that in the face of uncertainty about whether its policy is working it will hold rates for the time being. This will change market expectations.
Second, next month it should say that rates have peaked. This will end the market expectation of rises, for good.
Third, at the same time, the Bank should end its policy of quantitative tightening which is only being done to support high interest rates. This will take £80 billion out of the economy this year which the economy cannot afford. This should start rates falling in financial markets.
Fourth, in two months time the Bank should begin to cut rates. Let them start slowly, and ideally, then speed up. But this policy is essential. Not only will it slow down inflation, which interest rate rises are fuelling, it will also keep people in their homes.
And then the policy is to wait and see. No one in macroeconomics can ever predict anything precisely. But what we do know is that what is happening now is both not working and is causing very real harm.
In that case, what is wrong with trying something that might work and most definitely will do good?
I am very confident that good will flow from this move. Nothing can now reduce the upward pressure on prices more than a cut in the Bank of England's official base interest rate. It's time it happened.
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When your only tool is a hammer every problem looks like a nail.
But an experienced handyman will know that a hammer can’t work for lots of jobs so will look for something suitable to use.
Unfortunately, this insight seems to be beyond our current batch of bankers and politicians!
Markets now expect 6% base rate, so good to see that you are acknowledging that you were wrong on 31 May – and quiet rude to those who were trying to help you with your misunderstanding of gilts, rates and expectations.
U.K. rates are going up further….at least you have changed your tune there. Well done for correcting your earlier mistake and for being brave enough to know when you were wrong…
I was right to say that rate expectation was wrong then
I say it is wrong now
Why is it about what I said you don’t understand?
On the grounds that once you have dismissed all the other possibilities as untrue, the one reason that remains for increasing the interest rate, is the obvious one that it is being done to protect the pound exchange rate.
How else can you induce people to buy pounds, when as a result of Austerity, Brexit and Neo-liberal dogma the British economy is tanking, and that is tanking even according to the dishonestly massaged statistics provided by this rotten Tory regime.
Just hang out a big sign saying buy pounds and we will force the British public to pay through the nose to provide you with no risk profits.
Why do we want people to buy pounds at inflated prices?
I am venturing into an area where I have little knowledge but I think the key is the profit you can make borrowing in lower interest rate Countries and lending in the higher interest rate UK.
Is this not just a form of Carry trading?
It will be
Thanks so much for this post.
When I heard the news that inflation had not fallen this month I started thinking, as in your post, that it was probably due to rising interest rates themselves.
So I tried to search for any posts or papers that even discussed this possibility. I could find none. And yet, it is obvious that rising interest rates will, to some extent, feed through to prices.
Do you know of other good articles that describe this phenomenon? It would be nice to have some figures from numerical calculations if such things exist.
So, the BoE, as proxy for the government, are themselves stoking inflation. They could, of course, reduce inflation at a stroke by reducing taxes such as VAT and fuel excise duty. But they choose not to. Why not? Because they have this, false, obsession about balancing the budget. But, even within that constraint, they could still balance the budget (unnecessary and undesirable as that may be) by increasing taxes on the wealthy (that is, on precisely those people who benefit from higher interest rates). The government choose not to.
As I’ve said previously, this is unsustainable, which is becoming increasingly clear with the mortgage crisis amoungst other things. Therefore it will not be sustained. Interest rates will stop rising, inflation will reduce. But oh at what cost to too many citizens 🙁
No way should fuel duty be cut. One, driving is already subsidised and cars create a lot of damage to the environment and society. The cost to the user shouldn’t be reduced even further relative to (more socially beneficial) modes. Two, fuel duty already wasn’t increasing relative to inflation in the past 10 years. And, three, it would be another regressive policy as driving scales with income, so it would be a policy that disproportionality benefits the better off.
Don’t forget this isn’t just happening here, it’s happening in the USA and the EU too. This is (partly) what leads me to assume it’s part of an attack on the Middle Classes, themselves a recent phenomenon, made with a view to causing them to revert back to serfdom and usher in a new age of oligarchy, or neofeudalism, if you like. Or, whether you like it or not, simply a restoration of the same old feudalism we used to have centuries ago.
“Banks, oil companies and many companies in food supply chains are very clearly increasing their absolute levels of profit, and their profit rates.”
That is why the banking sector is doing so well; it profits hugely from an effective windfall profit from rising interest rates by making money both from the public, and the BoE. Oddly, the Government (BoE) is notably not benefitting from the increase in interest rates, although the government is desperate for income (to reduce the deficit and debt, because that is its obsession, and is squeezing the life out of the public with taxes); and this is an area in which the BoE has a clear entitlement, and the private sector has none.
The reason the BoE is not benefitting is because the profits (seignorage) the BoE makes from this activity is being transferred from the BoE to the commercial banks.
The Government chose to pay interest to commercial banks on CBRAs, following the Crash (see earlier threads), at the expense of Government. It need not do so. There were minimum reserve requirements established in the past (with no transfer of seignorage), which ended with the post-Crash reforms. Minimum reserve requirements could be reintroduced, and end this gratuitous subsidy to the private commercial banking sector of yet more windfall profits for doing nothing at all; made from the public profits due to the sovereign currency issuer.
The BBC is doing its propagandistic best to reinforce the message that wage increases cause price increases. Karen Ward, Chief Market Strategist at J.P. Morgan Asset Management, was interviewed this morning on the Today programme arguing for much higher interest rates, she did not specify how high, and for the country to be pushed into recession. This was because, according to her, UK inflation is now entirely homegrown and that we are seeing signs of the wage/price inflationary spiral and the Bank of England has to stop it by raising interest rates. The Today presenter, Mishal Husain, had neither the knowledge nor intellectual capacity to challenge Ward. A brief excerpt from an interview with a factory owner arguing that inflationary pressures were external was played as a counter, but the clear message was that people had to endure recession to tame the inflationary beast. Of course, it’s easy for the likes of Ward, who spent three years at the Bank of England, to demand of others that they sacrifice their livelihoods and lives for inflation – she won’t be affected. There is something uniquely monstrous about the financial establishment in this country, safely cocooned from the impacts of their policies. At what stage do the people targeted by these rate rises say enough and what will that saying look like?
I heard this too, and despaired. It really is irresponsible of the BBC to field such ignorance, and to have such woefully ill-informed presenters.
I am more cynical than you Richard.
I would say that the real purpose of raising interest rates is to open yet another channel for the upwards flow of money from the 99% to the 1%.
Inflation is just the excuse to do this, so it doesn’t matter if their policy doesn’t work to fix it.
The people who benefit from this have been pushing for higher interest rates for years. Up to now the Bank held firm.
I am more cynical than you Richard.
I would say that the real purpose of raising interest rates is to open yet another channel for the upwards flow of money from the 99% to the 1%.
Inflation is just the excuse to do this, so it doesn’t matter if their policy doesn’t work to fix it.
Interestingly BBC Radio 4 have now started referencing ‘pay inflation’ as a factor in every conversation about inflation. Because they know that even if it isn’t true, mention it often enough and most people will believe it.
I agree that it is
But I am seeking to build a counter-narrarive tio their excuses
The illusory truth effect where if we hear the same thing over and over then we tend to accept it as true and start to repeat it as if it were ourselves. It seems to be a glitch in humanity, vestigial behaviour, useful at one time perhaps but a vulnerability now.
I really like your sentence:-
“I could keep going. My point is that all the assumptions that the Bank makes on the impact of interest rate rises appear to be based on what economics text books say, and the relationship between economics textbooks and reality ceased a long time ago.”
It’s as though the UK is adhering to ancient religious texts from the planet Zog. This is pretty much what the late Queen said when she publicly enquired why economists never saw the GFC coming. Of course, a small number of heterodox economists did. You might have thought of course mainstream economists would have started to espouse much of the heterodox thinking. But no it’s not happened because mainstream economists essentially hold tenure at universities by joining Planet Zog’s doom loop cult. This of course has parallels with the McCarthyite “”commie hunting” in the United States of the late 1940’s and 1950’s. This affected many US economists who were attempting to think out of the box in a social democratic way but were certainly not subscribed to the abolition of free market capitalism in favour of a Marxist inspired overly dominant state led capitalism.
The cost of Brexit should have fallen out of the inflation basket surely as any barriers and setup costs were incurred more than a year ago. NIP for example.
Why? The cost is cincurred every day, and is growing as more and more Brexit measures come into operatiom
You didn’t think it was all done, did you? Far from ….
Just wait till October…
Thank you for your mention of a new barrier or cost that has been incurred in the last 12 months. Very hard not to notice them.
Bill’s comment is interesting – there are indeed new costs scheduled for October.
Great post, and wholeheartedly agreed.
The ‘de-politicisation’ of bank interest rates and the handing off of them to the ‘independent’ BoE is redolent of how austerity is portrayed – something that the ‘independent experts’ can handle and advocate and avoid blaming politicians.
Are we that stupid?
The thing is, if you were watching your mortgage rates going up you’d be so worried that I think you’d hold them ALL responsible.
And why wouldn’t you?
Bottom line: this is back-door privatisation of policy – we are being left to the market, and market is making hay at our expense.
Market capture is complete in this country. Just look at how we stack up elsewhere?
“Market capture is complete in this country.”
Indeed, it captured and fried the citizens brains and then abandoned them. You can’t get more stupid than the British:-
https://www.theguardian.com/business/2023/jun/20/uk-economy-in-growth-doom-loop-after-decades-of-underinvestment
“World-beating” in their economic thinking? Hardly!
Todays screaming headline from Gloomberg:
BOE TOLD IT MUST FORCE RECESSION TO TACKLE INFLATION
(You might get the article for free, but maybe not)
The gist:
Traders Set Sights on a Half-Point BOE Rate Hike
Bets for more Bank of England rate hikes continue to ramp up this morning, with traders now seeing 75 basis points of increases by August. That implies expectations for at least one half-point hike either at this week’s rate decision or in a couple of months.
Nice.
https://www.bloomberg.com/news/live-blog/2023-06-21/uk-markets-today-pound-ftse-100-and-bond-market-coverage?srnd=premium-uk#xj4y7vzkg
https://www.printweek.com/news/article/small-businesses-suffer-interest-rate-insolvencies
Just what Hunt & Bailey want.
Regarding corporations increasing prices, economist James K. Galbraith pointed out:
“in disturbed and disrupted moments, increased margins are a hedge against cost uncertainties, and there develops a general climate of “get what you can, while you can.” The result is a dynamic of rising prices, rising costs, rising prices again — with wages always lagging behind.”
Reference: https://medium.com/@monetarypolicyinstitute/notes-on-inflation-and-price-controls-bda34023344b
It’s called looting, and is reminiscent of the last days of Rome. You grab what you can and get out while the going’s good. Clearly I’m not the only one anticipating social collapse in some form.
In the paraphrased words of Hans Gruber (Alan Rickman) in the movie ‘Die Hard’
‘You asked for a recession Theo…..I give you the B…O….E’.
Austerity shortening the height of British children:-
https://www.theguardian.com/business/2023/jun/21/children-raised-under-uk-austerity-shorter-than-european-peers-study
Sunak and Hunt pondering supplying extra money to the NHS to purchase racks!
Staggering….
Compare and Contrast BBC article with Richard’s blog.
Make it of this what you will. Could it be that the BBC and other so called mainstream, city economists et al are now finally catching up with the Mile End Road Economists?
https://www.bbc.co.uk/news/business-65974092 – UK inflation shock: This is really grim By Faisal Islam
Economics editor
BBC Article: ‘Over the past 18 months the Governor of the Bank of England has told the BBC workers should not ask for excessive pay rises and companies should not hike prices too much either.
Core inflation, a measure of underlying and ongoing inflationary pressure that strips out month to month volatility, is, however, going up, even as it is in decline elsewhere in other major economies. The polite requests have not worked’
RM Blog: ‘It is my suggestion that the Bank of England has not only got their assumptions wrong, they are so blinkered that they cannot see that it is their own interest rate rises that are now stopping inflation falling by creating an upward inflationary cycle.
And we do know the Bank has got their assumptions wrong. They have, for example, already had to abandon their models for forecasting inflation because, as they have admitted, they simply do not work.
BBC Article: The response of Karen Ward, a respected City economist who serves on the chancellor’s council of advisers that the Bank of England “has to create a recession” partly to “nip in the bud” a spiral of wages going up and in turn pushing up prices, and then pushing up wages again.
RM Blog: ‘That means that the Bank of England gets its wish: if it keeps increasing interest rates it will eventually get the recession it desires. And let’s not pretend there is any surprise in this: the Bank has always wanted a recession to control inflation.
BBC Article: The markets are pretty openly questioning whether the Bank is in full command over where inflation is going. Financial markets and banks are effectively pushing up fixed term mortgage rates, without waiting for actual Bank of England decisions.
RM Blog: ‘I suggest four things. First, it should tomorrow announce no rate increase. It should say that in the face of uncertainty about whether its policy is working it will hold rates for the time being. This will change market expectations.
Second, next month it should say that rates have peaked. This will end the market expectation of rises, for good.
Third, at the same time, the Bank should end its policy of quantitative tightening which is only being done to support high interest rates. This will take £80 billion out of the economy this year which the economy cannot afford. This should start rates falling in financial markets.
BBC Article: ‘And the government’s own post Brexit policies on trade and workers may have lessened competitive pressures that would in the past have brought inflation down more rapidly.
RM Blog: ‘The first is Brexit. It has created continuing supply chain disruptions and has imposed considerable extra costs that are fueling continued inflation. This fact cannot be avoided.
I should get in touch with Faisal
I sincerely hope you do get in touch with Faisal, Richard. When you do, please offer him the chance to sit down with you and Danny Blanchflower for an hour or two – and invite all his fellow high-profile presenters to a Q&A on how the economy really works.
I have had similar thoughts over the last month. This connects it all together.
Why is there still inflation is an excellent question. After all demand is lower and global supply shocks are recovering. In a market economy we would expect lower inflation and I am increasingly unconvinced that the UK is a market economy. Some of the behaviour is what I would expect of an emerging market. Call it greedflation, markup inflation. Essentially these words are describing an economy where companies seem to operate above, or in a parallel system to a market. They are not constrained by market forces. Interest rates do not effect them.
The problem is very structural. Caused by a failure to invest.
Monopoly is a key factor here
Actually it seems more like scrabble.
Scrabble for food, scrabble for energy, scrabble for money.
Richard
Could you please let me have the section reference of the clause which allows the government to overrule the BoE. I’d love to quote this to my students, since it is always taught that the BoE is independent, albeit only to a limited extent.
https://www.legislation.gov.uk/ukpga/1998/11/section/19#:~:text=19%20Reserve%20powers.&text=(1)The%20Treasury%2C%20after,and%20by%20extreme%20economic%20circumstances.
Thanks.
Richard,
I noticed that UK PPI was down -1.5% MoM, when it was predicted to fall 0.5%. The graph is starting to show steep declines. Does this bare no relevance to the BofE? Is CPI not supposed to lag PPI?
Thanks
If the BoE is planning a recession of course PPI will be down
Put it this way. If you had borrowed a loan at base rate plus three percent at any time since 2009, the cost of finance would have been below four per cent until last year, but would now be approaching eight percent.
What would any business do if one of its key costs doubles? You would increase prices. That includes landlords, so interest rates will be almost directly increasing rents.
Meanwhile pay increases are below the rate of inflation. So it is hard to see that higher wages bear much responsibility for fuelling increased prices.
Imagine a simple business. Staff are paid 50 and sales are 100 leaving 50 of profit. Pay increases 5% to 52.5 and sales by 10% to 110. Now profit is 57.5, up 15%. So what is fuelling inflation there?
Good example
Thank you
Whilst hardly considering myself an expert, as an graduate in Finance & Economics some 30 years ago who is now an economics teacher in the Netherlands, I simply cannot find any economic logic in the BoE’s actions.
Therefore, it would seem the BoE is being used as an extension of tory policy to punish those on lower/middle incomes
Agreed
I think the comment Paul Langston makes above is important. One of my small criticisms of MMT is that it is weak on exchange rates.
Confession: For years I have been an amateur investor in the stock market. I have been burnt too often by buying shares in a company that appeared cheap, but were cheap because the company was in long term decline.
Increasing interest rates may encourage foreign investors to buy £s to buy UK bonds, improving the exchange rate and reducing the cost of imported goods. But if the UK is in long term decline, the £s that foreign bond-holders get back will be worth less and less.
Using interest rates to artificially raise the value of the £ may make imports cheaper, but it immediately makes it harder to export goods and services. In the longer term, I find it hard to see how the BoE is doing anything other than weaken our ability to develop and export the goods and services needed to maintain the value of the £.
Acting like the directors of a failing company, increasing dividends, knowing that the increase cannot be maintained
The climate crisis is also driving inflation. Record temperatures around the world. Mexico, India, Spain etc. Many of these countries produce the foods we eat.