We’re mostly relying on
one big, stupid tool to
combat inflation, says James Meadway

The Bank of England decided last week to push up its own interest rate in the biggest single hike in three decades, in an effort to restrain inflation. The effort is unlikely to work.

Inflation today is coming from sources that have nothing to do with the levels of interest rates being set in London. Russia’s invasion of Ukraine is the most obvious impact, with natural gas supplies in Europe and global grain and fertiliser supplies severely disrupted.

But ongoing Covid lockdowns in China, with the latest round of restrictions announced around the huge factories in Zhengzhou, are also squeezing the supply of goods, pushing up prices. And extreme weather events around the world, from heatwaves in Europe to floods in Nigeria, are not only devastating for those affected. They mean goods can’t be transported down dried-up rivers or harvests are damaged as crops shrivel in the heat, or are washed away in floodwaters.

It’s a far more unstable world, and this instability, whether political or environmental, is helping push up inflation in Britain to levels not seen for decades. Because Britain is so dependent on imports for essentials, about half the natural gas we use, for example, and about half the food we eat, instability in the rest of the world can have a very rapid impact on prices here.

The Bank of England knows this. It has been warning about rising prices across the world well before Russia invaded Ukraine in February. Bank of England Governor Andrew Bailey has even admitted that interest rate changes can’t necessarily do much about any of it. If inflation comes down (and the Bank forecasts that it will, somewhat, next year), it will be because of changes in those big global trends.

And yet the Bank persists in jamming up its own interest rate. It expects that this first rate change will then be passed on by the financial system to the rest of us in higher mortgage costs, higher credit card bills and so on. (If we are lucky, we might, eventually, find saving rates improve too.) It knows full well that by squeezing borrowers, already squeezed by rising prices, it will make life harder for most people – causing them to cut back on spending on non-essentials, and so worsening the expected recession.

It knows all this, and it still does it, because the belief, built into the Bank’s thinking on the economy, is that the spectre of unemployment in a recession will frighten workers away from demanding higher pay. It’s as brutal as that. But with regular pay currently rising at 5.4 per cent, and inflation at 10.1 per cent, most people are feeling a dramatic squeeze in their standard of living. Each pound any of us earns goes less far, because inflation means most things – especially essentials like food – cost more than they used to.

The real answer to this is to make sure people’s incomes go up by at least the rate of inflation – whether that’s wages and salaries, or pensions, or benefits. Rapidly rising prices but low pay rises have been very good for the biggest companies in Britain, with total profits of the 300 largest companies up 76 per cent since the start of last year. Those profits could be squeezed to offer higher pay to workers, or taxed to pay for higher benefits and pensions.

The Bank of England can’t do any of this. It mostly has one big, stupid, damaging tool it is expected to use to try to meet the target the government sets of 2 per cent inflation. (There are, potentially, other tools it could use, like its powers to create and destroy money. The Bank has just started “quantitative tightening”, in effect trying to suck money out of the rest of the economy.) But when inflation is caused by things outside its control, and when its model for controlling inflation involves inflicting economic pain on most of us, it’s surely time for a different approach.

The government could stop hiding behind the Bank of England when it comes to inflation. We’ve already seen the Energy Price Guarantee, which has stopped home energy prices rising quite as much as forecast this winter. Ministers could also make sure pensions and benefits go up in line with inflation, as well as pay for hard-pressed public sector workers. It could lift the level of the minimum wage to the £15 an hour being demanded by Britain’s trade unions.

All of these would be good, practical steps the government could take. Instead, it is considering “austerity 2.0” – a second, disastrous round of public spending cuts, that risk pushing our public services over the brink and that will worsen the expected recession. Instead of hiding away from its responsibilities, this government needs to step up – work on protecting people from the worst impacts of inflation with pay, benefits, and pensions rises, and keep up public spending to limit the worst impacts of any recession. We are currently set on doing the exact opposite – the worst of all worlds.

James Meadway is an economist and director of the Progressive Economy Forum, an independent thinktank (progressiveeconomyforum.com)