The UK economy is in a deep bind. On the one hand, consumer price inflation has hit seven percent and rising prices are hitting those on the lowest incomes the most. On the other hand, growth and employment are both low and raising interest rates threatens to choke off the recovery even further.
The consensus since the 1980s has been that interest rates are the only tool available to policymakers in the fight against inflation. Raising interest rates increases borrowing costs, which is supposed to discourage investment, reducing demand for raw materials and labour and bringing down prices.
But this trick only works when prices are being driven by rising demand in the first place. We are not in a situation in which overzealous businesses are buying up resources in anticipation of an economic expansion. Price rises are being driven by two factors: energy costs and supply chain issues.
Energy prices are rising thanks to the swift closure and re-opening of the world economy. When the world went into lockdown, demand for fossil fuels tanked—at one memorable moment oil prices appeared to converge on zero. Producers held back on releasing any new supply and when demand bounced back, we faced the issue of shortages. Putin’s invasion of Ukraine has made a bad situation much worse.
Then there are supply chain issues, which are exacerbating the energy crisis. Global shipping is still reeling from the impact of lockdown, which brought the finely-tuned global logistics system to its knees.
Renewed lockdowns in Shanghai have exacerbated the crisis and the shipping companies are taking advantage of the chaos to jack up prices. Those price rises are passed on to any consumers who purchase imports—which is most of them, especially in an import-dependent country like the UK.
The combination of the ongoing impact of lockdowns and the war in Ukraine is also causing shortages in a few critical sectors—from computer chips to sunflower oil—which are pushing up prices in other areas of the economy. The lack of semiconductors is, for example, making the production of new cars very challenging, which is what is pushing up prices in the used car market.
None of these issues is solved by raising interest rates. The only thing that the Bank of England would achieve by raising interest rates would be to engineer a recession, which might help the fight against inflation but only because it would increase unemployment and constrain growth.
And there’s another issue with raising interest rates. Higher borrowing costs don’t just affect the corporate sector, they affect households too—especially in an economy as debt-laden as our own.
Thanks to the combination of a decade of sluggish wage growth, the pandemic and the current cost of living crisis, people’s incomes have been squeezed about as far as they can go. The result has been a sharp increase in household debt (excluding student loans), which now stands at 123 percent of GDP.
This is lower than the peak of 145 percent in 2008, but still high enough to make rising interest rates a potential cause for concern, especially because much of the new debt is expensive, unsecured debt like credit card debt. Credit card lending increased by £1.5 billion in February alone—the largest monthly increase since records began.
The UK also faces some unique challenges because of the structure of the mortgage market. UK mortgage-holders are much more likely to have short-term or variable rate mortgages, which makes them more vulnerable to rising interest rates. If mortgage-holders start to default on their debts and potential buyers hold off on any new borrowing, house price growth could level off.
The impact of falling prices for first time buyers would be limited in this context, because borrowing would be more expensive and banks would be much less willing to lend in what looked like unfavourable economic conditions. Those with cash to spare would likely snap up cheaper housing, consolidating the massive inequities that already mark the UK housing market.
In short, raising interest rates isn’t going to fix the inflation crisis—or any of the other crises that the UK economy is currently facing. But the Bank of England doesn’t have the power to do much else.
The problem is that we view inflation as a neutral, technocratic policy problem, when it’s a political question—just like tax rates or social security payments. Raising interest rates will benefit some constituencies—notably banks—and harm others—particularly those with lots of unsecured debt. Letting inflation continue will benefit some—like debtors—and harm others—asset-owners and the poor.
Four decades of neoliberalism has convinced us that macroeconomic policy is best left to the ‘experts’ who can design a solution that works best for everyone. But the only outcome of this attitude has been the capture of our highest economic institutions by vested interests, who rule according to what will benefit them in the name of ‘the national interest’.
Democratic politics should be about making these choices clear and allowing different interest groups to bargain over who bears the costs. The most powerful tend to win these fights most of the time but working people don’t stand a chance if the choice isn’t being offered in the first place