With inflation running at above 5 percent for the first time since the financial crisis, policymakers are stumped. The orthodox response to high inflation is to raise interest rates. Increasing the cost of borrowing is supposed to curtail spending and investment, reducing the pressure on resources that can drive up prices when the economy is growing quickly.
But inflation is not always caused by high rates of economic growth running up against resource limitations. It can be caused by anything that generates a sudden disequilibrium between demand and supply for a particular commodity. Today, those commodities are fossil fuels.
Rising oil and natural gas prices—the legacy of a pandemic in which economic activity, and therefore fuel consumption, fell to very low levels leading to a reduction in supply—impact the prices of almost all other commodities. This domino effect has been particularly clear when it comes to food because of the important role of fertilisers derived from natural gas.
The result has been a particularly sharp increase in inflation for food, fuel and other consumer goods imports—exacerbated by the disruptions to supply chains also caused by the pandemic. This kind of inflation predominantly impacts the poor, and nearly 5 million people are now struggling to feed themselves in the UK as a result of rising prices.
This unusual situation raises an important question: what are policymakers supposed to do when inflation is high, but growth and investment are subdued?
Similar questions were posed in the 1970s, right on the cusp of the neoliberal revolution. In the UK, growth and investment were low but inflation was high, once again due to rising energy prices resulting from the formation of OPEC.
The breakdown of the relationship between employment and inflation that took place during this period is now seen as the death-knell for the Keynesian consensus. Given that inflation wasn’t being driven by high demand, it could not simply be solved by cutting government spending, raising interest rates or negotiating wage restraint with the unions. The problem was energy.
Naturally, this fact gave workers in the energy sector far more power. Miners in particular organised during this period to secure wage increases and curb the decline of their industry.
At the same time, neoliberal economists sought to use the ‘stagflation crisis’ as an opportunity to destroy the last vestiges of the social democratic settlement. They argued that inflation was being driven by irresponsible governments pumping too much money into the economy and failing to confront overly militant trade unionists demanding higher wages.
The differing interpretations of the crisis led to an epic confrontation between capital and labour that resulted in the Winter of Discontent, the introduction of a three-day week and, ultimately, the election of Margaret Thatcher.
Thatcher immediately set about institutionalising the neoliberal view on inflation by drastically hiking interest rates. The neoliberals argued that inflation was ‘always and everywhere a monetary phenomenon’: in other words, when prices were rising, it was because governments had lost control of the money supply. Raising interest rates—alongside cuts to government spending—would discourage borrowing and therefore limit the growth of the money supply.
This theory never worked in practice. Thanks to financial deregulation, borrowing under Thatcher increased faster than at any point in history. But the drastic hike in interest rates was never meant to reduce the money supply—it was supposed to create a recession that would discipline organised labour.
Monetarism quietly fell out of favour among central bankers over the course of the 1980s as it became clear that there was no easy way to use interest rates to control the money supply. But Thatcher’s interest rate shock—echoed by the Volker shock that took place in the US—is remembered as a necessary and decisive step to stem the ‘wage-price spiral’ of the 1970s.
Thatcher may have put an end to the crisis of the 1970s, but she did so by plunging millions of people into poverty and creating an economy that worked for a tiny elite in the South of England. A significant share of the political and economic turmoil through which we are living today can be traced back to the decisions made under her government.
What’s more, inflation ended up coming down over the long run because of the stabilisation of oil prices—something that would have happened anyway with the normalisation of OPEC’s role in global energy markets.
Thatcher’s singular achievement wasn’t figuring out how to use monetary policy to bring down inflation; it was figuring out how to use monetary policy to discipline the working class. Today, her descendants are attempting to do exactly the same thing.
Advocates of an increase in interest rates know that the problem we are facing is not an overheating economy, but the ripples sent out by the shock of rising energy prices. Making borrowing more expensive will simply constrain a stagnant economy even further, curbing consumption and investment—and therefore wages and jobs creation.
But just as it did in the 1980s, capital needs to discipline labour in order to protect profits. Some workers have had significant paid leave, or spent more time working from home, and are unwilling to return to the dismal working conditions of the pre-pandemic years.
Others have been less lucky, spending the last several years earning meagre wages in unsafe conditions. But many of these workers are organising—we’re seeing a slight uptick in trade union membership and activity that could begin to overturn a decades-long decline.
We are unlikely to see Thatcher-style monetary shock therapy just yet. Aside from anything else, organised labour remains in such a weak position that a dramatic interest rate hike (as opposed to the one recently announced) is an unnecessary tactic given the chaos it would cause.
But the right is already attempting to spread a narrative that blames workers for the current increase in inflation to justify a disciplinary response from the state. Just look at the governor of the Bank of England’s plea for wage restraint (which has rightly been ridiculed after it emerged that he earns more than half a million pounds a year).
One of the few ‘problems’ the UK economy emphatically does not face is inflated wages. Workers in Britain have experienced the longest period of wage stagnation since the 1800s. And while there have been wage increases post-pandemic in some sectors associated with shortages, these have been limited and are likely to be temporary as workers respond by filling the gaps.
The latest analysis by the Trades Union Congress (TUC) shows that wages are now £3 less than at the time of the 2008 Financial Crash. The general trajectory for wages post-pandemic is not yet clear, but early indicators suggest wage growth—particularly in the lowest-paid sectors—is reverting to pre-pandemic levels.
In this context, raising interest rates will have two effects. Firstly, it will increase the impact of inflation on poorer households by making their borrowing more expensive. In fact, it is likely to push millions of families deeper into debt.
Second, it will discourage investment in an economy where productive investment was already dangerously low before the pandemic started. This will mean fewer jobs, lower productivity and lower wage growth over the long run.
In other words, higher interest rates will translate into even lower living standards for the millions of people already being severely impacted by high inflation. What’s more, they won’t impact inflation until energy prices come down, which will only happen with an increase in supply.
Rather than raising interest rates, we should be arguing for price controls over the short-term, and public support for the provision of basic necessities over the long-term—perhaps through something like a national food service.
Investment in renewable energy is critical for so many reasons: to keep prices low, maintain energy security, decarbonise, create jobs and recover from the pandemic.
Inflation is always political—inflation itself, and the response to it, benefits some groups and harms others. We cannot allow right-wingers to get away with blaming workers for a set of problems caused by capital.
We would not, after all, be facing this problem had previous governments taken seriously the need to invest in renewable sources of energy. And energy companies like Exxon Mobil and BP are seeing bumper profits as a result of rising oil and natural gas prices.
Workers have borne the cost of every crisis in at least the last fifty years—they cannot, and will not, be forced to bear all the costs of this one.