Conor here: Richard Murphy examines central bankers eager to do their part in helping to speed up the breakdown.
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.
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.
