In an article published yesterday in the Financial Times, Megan Greene, an external member of the Bank of England's Monetary Policy Committee, argued that the UK may need higher interest rates if the war in the Middle East continues and energy prices rise as a consequence.
Her concern is that rising energy prices might trigger what economists call “second-round inflationary effects”. In other words, workers might seek higher wages to offset rising living costs, and companies might raise prices to protect their profit margins. That combination, she suggests, could create sustained inflation that would require monetary policy intervention from the Bank of England. In other words, she thinks they might need to raise interest rates.
I think she is wrong, and dangerously so.
The first point to note is that an increase in oil or gas prices is not necessarily inflation in the conventional sense. It creates a relative price change and a resulting economic shock as people and markets adjust to energy becoming more expensive. That adjustment will undoubtedly make many people poorer because they will have to spend more on energy in future and have less left over for other things, demand for which might well fall as a result, with potential impact on their prices.
But that is not the same thing as a generalised inflationary process generated by excess demand. In that case, what Greene is really arguing is that the Bank of England should deliberately ensure that people cannot protect themselves from this process of adjustment that might result in a loss of income. Her logic is that if workers secure higher wages to offset rising energy costs and businesses can pass both those labour and higher energy costs on, the initial shock might spread through the economy. So she says, interest rates should rise, economic activity should slow, unemployment should increase, and bargaining power should be weakened, even though there is no actual increase in demand in the economy as a result of what is happening, and the reverse might well be true.
The question is whether it makes any sense.
Who is responsible?
The first problem with Greene's argument is that it treats the victims of an energy shock as if they are somehow responsible for it.
If a war in the Middle East disrupts energy supplies, British workers did not cause that problem.
Nor did British pensioners.
Nor did British households struggling to pay their mortgages.
Yet the response Greene proposes suggests that these groups should bear the burden of this price adjustment over which they have no control and for which they have no responsibility. That represents a very peculiar concept of economic justice.
The alternative would be to recognise that energy price shocks are distributional events. Someone must undoubtedly bear the cost, but the real question is who might that be?
If energy companies increase profits, as may well happen, or if commodity traders benefit, or if financial markets exploit volatility, as they almost invariably do, then there is a strong case for intervention to limit those gains, or to tax them.
Likewise, there is a strong case for supporting households whose real incomes are damaged by events entirely beyond their control.
What there is not a strong case for is deliberately engineering an economic crisis by raising interest rates with the intention of suppressing wages as a consequence of increasing the unemployment rate in the economy, which is what Greene is proposing.
The evidence from recent years
The second problem is that recent experience hardly supports Greene's confidence in monetary policy.
The Bank of England raised interest rates aggressively from late 2021 in response to inflation created by temporary supply shocks caused by Covid and inflation driven by commodity traders after the commencement of the war in Ukraine.
Mortgage costs rose sharply.
Business investment weakened.
Economic growth stalled.
And yet much of the inflation that followed Russia's invasion of Ukraine was always going to disappear once energy prices stabilised, as I predicted at the time, and that is exactly what happened.
Higher interest rates did not create more gas.
They did not create more oil.
They did not reopen supply chains.
They did not end Putin's war, any more than they will end Trump's now.
What they did do was transfer very 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 obvious why repeating it now would produce a better outcome this time.
The real concern
What, however, I find most revealing in Greene's argument is her suggestion that inflation expectations may now be more sensitive because inflation has remained above target for much of the past six years.
There is a curious circularity in this claim. As we know, the Bank of England has repeatedly failed to hit its inflation target, very largely, I would suggest, because it has repeatedly misdiagnosed the causes of inflation. It has repeatedly insisted that inflation would prove temporary, and so reacted too late, only to then subsequently tighten policy aggressively, with hardship being the only net outcome, but with the inflation always passing of its own accord, as history proves it always does
Now, however, it is claimed that because inflation expectations may have become less stable, interest rates should perhaps rise again. In other words, the solution to the consequences of previous policy failures is more of the same policy.
Please excuse me if I am not convinced by that argument.
If the current conflict pushes up energy prices, the sensible response is to identify precisely where the inflationary pressures are arising and to address them directly.
That may mean we need windfall taxes.
It may mean we need price controls, or even rationing, in some markets.
It may mean that income support for vulnerable households might be necessary.
It might even mean that increased public investment is required to accelerate the transition away from dependence on fossil fuels.
All of those options address the source of the problem. Higher interest rates do not. They simply redistribute pain.
What Greene's article actually reveals, then, is that much of modern central banking remains trapped in a framework that treats unemployment and weakened bargaining power as acceptable tools for controlling inflation. Its solution to any problem is to pass the buck to those least able to manage it, with the least blame for it, and the lowest capacity to handle the consequences.
That is the consequence of the power assumption implicit in orthodox economics, with its inherent biases to those already well off. Call it a bias towards the survival of the fattest when measured by wealth, if you like.
This orthodoxy does, however, have a remarkably poor record when confronted by supply shocks, energy crises and geopolitical instability.
The lesson of recent years is not that interest rates should rise more quickly. It is, instead, that central banks should be much more cautious about assuming they can solve every problem by making most people in a country poorer as a result of their policy decisions, because that is what higher interest rates are deliberately intended to do.
The simple fact is that if another energy shock is coming, making millions of people poorer is not a solution. It will simply add a second crisis to the first and compound the shock the economy will suffer.
Megan Greene is not offering a solution to our problems. Her goal, and that of the Bank and the ideology she serves, is to make everything very much worse once a crisis has begun by imposing additional and unnecessary poverty by imposing interest rate rises, and that is why, right now, reining in or even abolishing the supposedly independent powers of the Bank of England is one of the most important things the government can do. The people of this country really cannot afford Megan Greene and her deeply misguided ideology.
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Ms Greene can sprout utterly crass neoliberal ideology because she is part of the financial elite that requires the current economic system to benefit them and their ideological influencers.
The looming Trump Great Depression is being caused by the actions of Trump and others.
Why must I and the rest of the UK population have to endure yet more austerity as a result of Trump and neoliberalism?
Pushing interest rates up will not solve the impending economic crisis it will as you write make it far far worse.
It was encouraging to read the early comments, critical of Megan Greene and leaning much more to the Richard Murphy view.
Dusting off my PhD in the Bleeding Obvious………
If Interest Rates are increased and the biggest household borrowing is mortgages
1. Most these days are on fixed rates, and
2. The number of UK Households with mortgages is much lower than it was
So if we want to control inflationary pressures by taking money out of the economy why not use taxation instead where it can be targeted, what on earth is wrong with that idea?
As a former lecturer of mine once said using interest rates to control the economy is a bit like pulling a brick across a table with a rubber band, nothing happens for ages until it hits you in the head – and that was in the days of almost everyone being on variable rate mortgages.
Much to agree with
” … workers might seek higher wages to offset rising living costs, and companies might raise prices to protect their profit margins. … she thinks they might need to raise interest rates.”
… which would increase living costs, eat into profit margins and thus encourage workers to seek higher wages and companies to raise prices.
Am I missing something?
I disagree with one thing in the piece. It does not redistribute the pain. It adds to the pain, and amplifiers the damage.
Further, as some businesses and households will be pushed past their capacity too adapt, insolvencies will be increased by the suggestions if implemented, creating second round economic challenges.
Central banks should be smoothing out volatility, not amplifying it. This means raising interest rates when there is an excess of domestic demand, potentially, but not when domestic household led demand is already weak.
Agreed
A cursory glance at her background tells you all you need to know – we are in Chomsky/Andrew Marr territory. If her ideology was other than what it is, she would not be on the BoE committee. The problem with these people, they never debate in public against those that can show that their beliefs & policies (& the outcomes from polices) are wrong and injurious to the UK. This is a normal situation, because those in power do not want such debates to take place. Instead we have propaganda such as the FT, reinforcing the party line. Late-Soviet-Britain.
The problem is also the ‘independence’ of the BoE, whose only tool to manage inflation is interest rate manipulation. If you only have a hammer, you will just hit things indiscriminately, rather than choosing the right tool for the job.
Your analysis makes sense to me. Will the other members of the Monetary Policy Committee overrule her or are they all too divorced from real life?
They will agree with her
Letter sent to MP.
Incidentally, I had a reply to my letter about the need to disengage from Palantir, which had been passed on to another MP, and replied to by a third. Basically, they said, due process had been followed, the two biggest contracts were initially awarded by previous government, and any specific questions should be directed to the relevant department. And please thank your constituent for writing on these important matters. So, nothing to do with us, ask NHS and MOD…
Ach y fi.
I agree with your analysis. It is infuriating that economists keep peddling the same old derp.
Greene worries that workers might seek to achieve higher wages to offset price increases, as well they might. Workers always seek to achieve higher wages, price rises or no. And if they could do so it would already be happening. It is not, ergo workers are not succeeding in pushing up their wages. Greene doesn’t need to worry on that front (although the workers do).
Then, as I understand it, her argument continues that if workers push up their wages then companies will push up their prices to compensate. A classic wage price spiral. But, again, if companies could charge higher prices presumably they would already be doing so to make more profit. What, they hadn’t been bothered about their profit and hadn’t thought of raising them until prompted by their workers? What tosh. So Greene doesn’t need to worry about that part of her argument.
So Greene is just being driven by group think that, “yikes, prices are rising, must put up interest rates”. That’s nonsense. Furthermore, even if interest rates are raised, their full effects are not felt for months, or more than a year, by which time this one off increase in price will be over. As it was with previous episodes of endogenous price increases or, more likely (hopefully), it will have reversed.
Much to agree with
And economically correct
Obviously engineering high interest rates to compensate for upcoming stock market crash they will have helped create.
Used wisely, money can transform the lives of everyone for the better, if we prioritise meeting real needs and using money to help meet those needs. But the Government and institutions like the Bank of England focus on managing money in accordance with a set of arcane rules, and think that somehow things will get better. They’re wrong. Things will only get worse.
Tim Morgan is, in many ways, on the same track. #325: The long run | Surplus Energy Economics
As usual, one is rendered speechless by the incoherence of this throbbing member (hint) of the MPC. Do not increases in interest rates put up wage claims/prices – a natural response to an added cost for God’s sake to the cost of living, credit, investment etc. I do not see the connection – sorry. Are we saying that people’s income/wages are paid for by loans? Are they not sourced from income from selling goods and services? WTF? I bloody hope so!
To be frank, the only people who will benefit from this idea are their rentiers with their loan books. This idea that increasing interest rates deflate prices is bollocks; it inflates returns on existing loans – period, end of.
Megan Greene is simply a rentier shill, with rentiers being the harpies of our time. Greene is a female and be assured that my opinion of her actions is driven by the disgusting self-interest she represents – not her gender.
I went on her LinkedIN page and made a comment on the article (which she was headlining). My first word was “Trash”. I then linked to this site and the blog. Doubtless she will remove it. People like her are unable to handle criticism. Talentless ciphers, no-marks, never-weres = the establishment.
On a related note: Tuesday, Netherlands, giving a presentation @ a tech conference on a piece of electronic kit that I specified to cure a particular network problem. Half the audience point-blank refused to believe that the problem it cured (unbalanced load on the DNO network) was a problem and also point-blank refused to believe that the kit solved the problem. This despite charts & hard evidence etc. I was laughing at the end @ the imbecility on display – which made things worse – good! (imbecility not so different from that displayed by Greene). Don’t think UK serfs will be laughing if Mrs Greene’s medicine is used.
What, in the history of the behaviours/actions of the B. o. E indicates that there is any functional evidence of practical care for regular citizens?
What is the proportion of rentiers on the governing body compared with the proportion of non-rentiers?
I can’t find such evidence
Looked at differently, the MPC is dominated by mainstream economists, mostly academics, plus some City types. As such they have a very neoliberal view on how the economy works and should be managed, biased to the interests of finance. Not rentiers themselves, but arguably biased towards the interests of rentiers.
True
Might information and actions relating to inflation be better based if inflation were differentiated into internally caused inflation and externally caused inflation?
Might it be the case that, basically, the wealthy have a significanl reonsibility for internal inflation and the not-wealthy have to pay the price of current inflation actions by the B. o. E.?
That will always be estimated, but basic recognition of the fact that this differential exists is key.
[…] By Richard Murphy, Emeritus Professor of Accounting Practice at Sheffield University Management School and a director of Tax Research LLP. Originally published at Funding the Future. […]