03 May 2023
As the Bank of England chief economist says Britons must accept they are poorer, the Jupiter Merlin team discuss the predicament facing central banks.
“Britons need to accept they’re poorer”. To which he might as well have added, “so suck it up”. This week from his ivory tower in Threadneedle Street, thus pontificated Huw Pill, the chief economist at the Bank of England. That the Resolution Foundation also published an analysis concluding that 37% of people aged 35 to 44 have resorted to formal borrowing (credit cards, overdrafts and loans etc) to make ends meet through the cost-of-living crisis makes the pill (pun intended) even more difficult to swallow. As a statement of fact, Pill’s observation is nothing less than the truth. But in a message of tough love from an ex-Goldman Sachs banker, it’s not going to make him many friends. It’s fine for journalists and commentators such as us to offer such judgements; we don’t make policy. But for the chief economist of the national central bank, whose principal mandate is to maintain price stability? As a response, it is literally hopeless. However true it might be, fine to think it, Huw, but best not to say it.
But the Bank has form here; after all, it was only last year that Pill’s hapless boss, Governor Andrew Bailey (a man who simply oozes a lack of confidence), made a memorably lame and ineffectual plea to the Great British Public: please, pretty please, not to ask your boss for a pay rise because it’s unhelpful. We all know what he meant. But given the decline in real earnings over a prolonged period going back to the Great Financial Crisis, and the public faced with a runaway cost of living, his sentiments were simply not grounded either in sense or reality. As it happens, given that private sector wage growth currently averages 7% and the public sector, beset with widespread industrial action, is averaging 5.3%, his exhortation fell on deaf ears.
These utterances from the Bank of England are surely symptomatic of the dawning of a simple fact: the Bank of England does not control UK inflation. It can and does influence it with the limited levers at its disposal. Those are principally: control of the money supply; determining the benchmark cost of borrowing through the base interest rate; and providing or constraining liquidity to the markets via its programmes of bond purchases (quantitative easing, or QE) or bond sales (quantitative tightening, or QT). But control? No. If it did, the current rate of inflation would not be a multiple of five times greater than the Bank’s mandated target of 2%, nor would it have been significantly adrift of that target for the past two years.
If this seems like a statement of the obvious, it needs making because there was a time, not so very long ago, when central bankers really believed that they actually controlled inflation. Former Governor of the Bank of England, Mark Carney, said so in a symposium hosted by the Financial Times and attended by the author.
Inflation is complex. It has many moving parts sometimes with component forces all heading in the same direction simultaneously, sometimes pulling in opposite directions and effectively cancelling each other out. Some of those forces are universal and largely governed by the laws of supply and demand (e.g. commodity prices), but are sometimes also affected significantly by officially imposed barriers (e.g. Putin weaponising gas supplies; the sanctions regimes applied variously against Russia and Iran) and tariffs (as imposed by Donald Trump under his “America First” campaign). Others are national and to a greater or lesser extent subject to government legislation (e.g. labour markets, national tax rates etc) or fixed by regulators and politicians (e.g. government stepping in last year to control domestic gas and electricity prices). The overall result is encapsulated in a single comparative figure reflecting a carefully chosen but limited basket of what are supposed to be representative goods and services bought frequently by most people. That every individual has a different portfolio of financial commitments, different needs for goods and services and each makes their own lifestyle choices, one’s personal rate of inflation or annual change in the cost of living may differ widely from the official national figure.
But all that notwithstanding, both the Bank and the government must directly share at least some responsibility for our current predicament. Contributing to our all being “poorer now” is 15 years of ultra-loose central bank monetary policy with easy access to cheap or free credit (indeed, in the eurozone with negative deposit rates and bond yields, governments being paid to borrow money, accumulating punishingly high levels of debt when interest rates rise) contributing to the zombie economy. An existing problem was only added to by the exogenous shocks of a pandemic and a war.
The virtual extinction of Darwinian monetarist economics in which markets set the cost of capital rather than the central bank manipulating it through QE is a prime factor. Badly run companies should be allowed to go bust. Their labour and capital can be recycled into better run operations. It maintains a healthy, match-fit, competitive economy, essential to expanding national economic growth and wealth. In today’s investment world, exacerbated in the aftermath of the pandemic by the societal shift towards stakeholders’ interests over shareholders’ (the shareholder is merely one stakeholder and rapidly dropping down the pecking order), the ability of poorly run businesses to refinance without any great incentive to improve their practices leads to the build-up of surplus capacity, including labour and capital. It increases inefficiency and frictional costs; it drives down real wages; it undermines productivity and it creates an enduring and corrosive fiscal drag on the overall economy.
Governments suffer the same self-inflicted problems. Ours are a microcosm of a broader geographical malaise. As seen through increasing levels of state intervention, governments see themselves as better capital allocators than markets. Using accountants’ language, if the private sector is a ‘profit centre’, public services are seen as a ‘cost centre’. There is still an obligation placed on governments to demonstrate value for money for the taxpayer, but the emphasis is on less precise cost/benefit analysis rather than the private sector imperative of profits and returns on investment. It is all too easy for governments to fall into the trap of thinking that more money will improve services, and to borrow it on the never-never (or when borrowing is constrained, to raise the revenue by taxation), when often what is needed is fundamental operational reform. Spending money is easy; root-and-branch reform is exceedingly difficult, too often relying on that tiny minority of the politically safe or brave to implement it and see it through. But without that discipline, public spending runs away while the services it supports seldom improve. That too is enduringly corrosive. The whole economy suffers: sub-par growth rates (what the International Monetary Fund accurately describes as “feeble”) become the norm; the tax burden increases; competitiveness against international peers risks declining.
Adding to the Bank of England’s discomfiture is the significant differential opening between our own annual rate of inflation and those of our competitors. Looking at the March data, ours remains in double digits at 10.1% (down from a peak of 11.1% in October); the eurozone has 6.9% while the US is almost exactly half ours at 5.0% (and has ‘enjoyed’ 9 consecutive months of a slowing rate). While the UK rate is proving sticky at elevated levels, in contrast March saw Germany’s rate fall 1.3 percentage points against February. While all the principal central banks are still minded to raise interest rates further from today’s levels to restore inflation to the 2% target shared by many of them, the Bank of England’s predicament is more acute. Caught between the proverbial rock and the hard place, if it pauses or cuts rates now (as insisted upon by outgoing Monetary Policy Committee member Sylvana Tenreyo) it is effectively capitulating, admitting the game is up for the Bank; on the other hand, as Pill has recently suggested in another speech, the Bank must continue to raise interest rates actively to manage inflation. In doing so, adding to the cost of capital, we all take the strain financially making us even poorer. But the long-term corrosive effect of enduring, embedded and elevated inflation is much worse.
The upper limit for interest rates, as we have discussed before, is the indefinable tipping point at which the cost of servicing the debt in circulation itself becomes so much of a financial and economic burden that systemic cracks begin to open again, as seen in March in the banking sector.
But short-term interest rates are ‘tactical monetary’ problems. At the strategic level, surely fiscal prudence needs restoring. We have to start living within our means again, whether it be the government, companies or us as individual consumers. However difficult politically (“eye wateringly difficult choices” according to Jeremy Hunt as he announced and then promptly deferred them until after the election), it should be an imperative for the government books to balance, reversing the current century’s unbroken trend of government deficits. But for that to happen, it requires two things: 1) an intellectual revolution on monetarist economic ideology and 2) a major outbreak of political bravery to make those hard choices and to see them through. Voters are not idiots. As both Margaret Thatcher and Ronald Reagan found in the 1980’s far from being anathema to the electorate, if the case is made clearly enough for strong medicine it can prove popular too.
Huw Pill says we are all poor. The IMF sees long-term growth as “feeble”. It is a desperate message. It is as though both imply that that is our lot. That absolutely should not be the case! Whatever your political persuasion, at least with a monetarist alternative to challenge the all-pervading Keynesian consensus there would be a full and frank debate. You would be offered a genuine choice to make, which can hardly be said of the current runners and riders. Who’s up for the challenge? Anyone…?
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