Monetary policy mayhem, or how not to solve the ‘cost of living’ crisis (part 1 of 3)
For central bankers, the real crisis is their inability to control inflation - and workers are likely to pay the price
Is the ‘cost of living’ crisis really a crisis? This is not to downplay the difficulties being endured by millions of households as a result of rising inflation. But it is not evident that political elites recognise these conditions as a crisis.
Crises involve disruption to a given order, but also, crucially, the absence of immediate solutions to restore order. I detect little sense that the UK government is in crisis mode on this issue: the recent £15 billion ‘Cost of Living Package’, for example, does not represent an unprecedented intervention, in scale or nature.
And despite the many hardships, there is not yet an organised push from below to force a more transformative policy response. This is perhaps because, at the moment, more affluent households have been spared the full impact of inflation. Or it may be that these groups fear the medicine now required more than the inflationary disease. (I will discuss the medicine in parts 2 and 3 of this post.)
Supply and demand
Let me be clear: the rising cost of living should be seen as a crisis, with recognition that the tools we need to address it are not yet in use or being considered.
The Bank of England expects inflation to reach 11% by October. In response, it has begun to steadily raise the Bank rate. It is hoped that this makes borrowing more expensive, therefore reducing aggregate demand. Less money will be created, less money will be spent, things will cost less.
Raising interest rates is what central bankers do, so that’s what the Bank is doing. Sadly, it is expected that recession and higher unemployment will follow. In short, a price worth paying for price stability (or at least its semblance).
The problem, of course, is that high inflation at present is not a consequence of excess demand, but rather supply-side issues caused by a web of Brexit, the Russian invasion of Ukraine, the ongoing impact of the pandemic, climate change, anti-competitive practices, and dysfunctional supply chains. Monetary policy has very little jurisdiction.
Class struggle
There are solid, progressive reasons for controlling inflation.
Rising prices are obviously a class issue, given that poorer people spend a larger portion of their income on essentials they cannot suddenly buy less of. There is also evidence that the Jack Monroe thesis – that the price of low-cost food is rising faster than the overall trend – is at least partially correct.
More generally, we need to keep in mind what inflation is. When a firm’s costs rise, it increases what it charges customers, in order to retain a certain rate of profit (or some approximation).
Fair enough, you might think. But workers who produce the goods and services from which firms profit are also the consumers of these goods and services. If their cost of living rises faster than their earnings, they get poorer – essentially to protect capital’s income ahead of their own.
(Energy companies continuing to pay massive dividends to their shareholders while the cost to consumers rises sharply is a gruesome illustration of this relationship.)
And to rub it in, workers are discouraged from demanding higher wages in order to meet higher living costs, since the extra spending that would result would make inflation worse (the so-called ‘wage-price spiral’).
Such arguments are the bread-and-butter of the post-Keynesian perspective on economics, pioneered by Michael Kalecki and Joan Robinson. It was given an airing in the Financial Times this week, but for the most part the relationship between inflation and inequality is entirely absent from the discourse of policy elites and the UK media.
Not zero
This is not to suggest that capital likes inflation. It risks eroding the value of financial assets. And capital has an interest in labour being able to reproduce itself, which is jeopardised if living costs are too high. And it is especially bad for the UK, where a financialised growth model requires an over-valued currency.
But a little inflation is good for capitalism. Keynes argued of course that inflation creates demand, since people are encouraged to spend in the present, knowing that prices will rise in future. And it helps to erode the value of financial liabilities.
This is why the emphasis in most countries is on stable rather than zero inflation. The UK has an inflation target of 2%, and the Governor of the Bank of England must provide an explanation to the Chancellor if it falls consistently below this level, as well as rises above.
The 2% target is based on political as well as economic considerations. It is impossible, in a liberal democracy, for pay rises to be avoided (since workers are voters too), so some inflation allows for the flexibility capital requires to manage its profitability.
Centrality
Inevitably, central bankers like to place monetary policy at the centre of the story of managing inflation. This script is given intellectual weight through theoretical constructs such as the ‘natural rate of interest’, and the Phillips curve.
The latter tells us that controlling the price of money (i.e. interest rates) is the best way to manage inflation, and therefore unemployment. To reiterate, higher interest rates mean money costs more, so less is created, and less money equals lower prices.
But it seems that central bankers know this account is too simplistic, if not largely incorrect. A recent paper published by the US central bank, the Federal Reserve, demonstrated that inflation instability in the 1970s was overcome not through effective monetary policy, but rather the destruction of workers’ bargaining power. Neoliberalism, not monetarism, cured inflation. Learning from the post-Keynesian emphasis on class relations, the paper develops instead a ‘Kaleckian Phillips curve’.
Naturally, the Fed is nevertheless still using interest rates as the first line of defence against present-day inflation in the US, increasing its main rate by 0.75 percentage points this week – the largest rise in 30 years.
We should probably expect sharper rises in UK interest rates to follow suit. But the Bank’s Governor, Andrew Bailey, has already let slip that this will not be sufficient to control inflation. Bailey has asked workers to lend a hand, voluntarily snuffing out demand by forgoing pay rises even as their standard of living declines.
We should acknowledge of course that Labour governments in the UK have in the past also asked workers to moderate wage demands to control inflation, through ‘incomes policy’. But incomes policy operated at a time when workers actually had some bargaining power, in the post-war era. The notion of asking today’s workers – who have much lower levels of employment protection and trade union membership, and have experienced a sustained period of earnings stagnation – to shoulder the burden of price stability is appalling.
I suppose we should be alarmed if central bankers are beginning to endorse post-Keynesian theory, even as they deploy conventional monetary policy tools, since it might herald another wave of attacks on workers’ rights.
This would be a strange place to end up in, if your objective is to alleviate rising living costs. But economic policy-makers are fighting a different war, protecting the pound at the behest of finance. As such, inflation is not the cause of a cost of living crisis; inflation is the crisis, and workers’ living standards may have to deteriorate further to overcome it.
Parts 2 and 3 of this post will explore contemporary monetary policy a little more, and some of the wider policies which could be introduced to alleviate rising living costs.