Today the Bank of England (the UK’s central bank) raised interest rates, for the fourteenth time in less than two years. It has chosen to inflict more pain on households already suffering a heavy burden of personal debt and reeling from a cost of living crisis. Why?
The cost of living crisis is being used by both main political parties, in the run up to next year’s general election, to justify their political choices. Clean air, clean water, nature restoration, above inflation pay rises, affordable childcare, free school breakfasts, NHS dental treatment, affordable housing, better social care provision, universal access to bank services, compensation for victims of the contaminated blood scandal - you name it, these are all recognised as desirable. But making progress with any of them, we are told, has to wait until the cost of living crisis has been solved. Above all, ’fiscal responsibility’ must come first. And, given an unwillingness to raise taxes, that means a continued squeeze on living standards.
From which one might suppose that both Conservatives and Labour are laser focused on coming up with solutions to the cost of living crisis. Except they are not. If anything, what they are committed to - interest rate rises and pay restraint - make that crisis worse. They see no alternative as possible, because they are constrained by the straitjacket of neoliberalism.
Two aspects of that straitjacket are particularly limiting. One is a belief that the national debt is a burden which needs to be reduced. The other is a belief that inflation can be controlled only by raising interest rates.
National debt and personal debt
Both the Conservatives and Labour believe that national debt is a burden. They have each set a fiscal target to reduce national debt as a percent of GDP over a five year period. Which begs the question why they see national debt as a burden to be reduced?
National debt is what accumulates when governments spend more than they reclaim in tax. Claims that national debt is like personal debt, which has to be repaid at some point, are simply wrong. As bonds that have been issued by government mature, they are repaid with receipts from the issue of new bonds. Current levels of personal debt are problematic. Current levels of national debt are not.
Whether or not it is wise to reduce national debt should depend not on an arbitrary financial target but on what resources are available, and on the balance between government spending and tax that is needed to support wider aims. Often these wider considerations - to reduce unemployment, for example, or to cope with a crisis like a pandemic - favour spending more than is received as tax, expanding, not reducing, national debt. At other times, if there is full employment and the economy is overheating, taxing more than is spent, and reducing the national debt, may be what is needed to counter inflationary pressure.
It is often forgotten that what is called national ‘debt’ is a government backed deposit facility for savings - gilt-edged securities held by pension funds, savings accounts with NS&I held by private individuals, etc. When saving with commercial banks is as risky as it has become since 2008, it is not surprising that government-backed security has become highly valued. Governments determined to reduce national debt often disguise that this reduces the secure assets that benefit private individuals.
Inflation
Inflation is a measure of how average prices have changed over a 12 month period. We have become used, in most years since the 1980s, to inflation rates that are close to zero. Some neoliberal politicians claim that this is due to the success of their policies, but the main reason in reality was the emergence of China, a relatively low labour cost economy, as the major supplier of manufactured goods and components in the global economy. When the Covid-19 pandemic crippled the Chinese economy the result was global supply chain disruption and a spike in inflation. This was followed by more inflationary pressure as the Russian invasion of Ukraine disrupted energy and grain supplies. These spikes in inflation were supplemented in the UK by the impact on the labour market and import prices of the government’s pursuit of a hard Brexit. UK inflation peaked at 11.1% in October 2022.
Shocks such as these have often in the past been short-lived in their effect on inflation - prices rose, and then settled at their new level, so that inflation, which measures what has changed over the previous year, rose and then fell. A problem for the UK at present is that inflation is falling at a slower rate than in other countries - it was still 7.9% in June 2023. The Treasury has concentrated its counter-inflation efforts on restricting public sector wage rises, ignoring the facts that public sector pay rises have been consistently below inflation for over a decade, and that with most public services pay levels have no direct effect on consumer prices.
To understand why inflation is coming down so slowly the UK, public sector pay and overheating can largely be ignored. Assumptions that market competition would ensure that cost reductions would be passed on to consumers as lower prices have not materialised. Instead, company profits have increased, with much of the rewards passed on as dividends to shareholders. In some sectors, particularly food, Brexit has continued to push up costs - both the cost of imports and the seasonal labour force in the UK food industry have been affected by the continued failure of the government to come up with satisfactory post-Brexit trading and migration policies.
Government action to curb profiteering or to ease supply chain constraints has been almost non-existent in the UK. Instead, alongside its attack on public sector pay, the Treasury has encouraged the Bank of England to raise interest rates. One of the tenets of neoliberalism is that politicians cannot be trusted to implement the tough policies that it suggests are needed to control inflation. So the main task of controlling inflation falls to its central bank, in the UK the Bank of England. The Bank of England is nominally independent, but it is publicly owned and tasked with using monetary policy - essentially setting a base interest rate which influences interest rates throughout the economy - to steer the economy towards a target inflation rate set by government, an arbitrary figure of 2%.
Interest rates
Inflation in the UK rose from 0.6% in November 2020 to 4.6% in November 2021, when the Bank of England base rate was only 0.1%. In an attempt to control a rapidly rising inflation rate, the BoE raised its base rate seven times, to 2.25%, before inflation peaked in October 2022. Responding to the slowness of the fall in inflation since that peak, the BoE continued to raise interest rates a further seven times, reaching 5.25% in August 2023.
When a rise in its Bank Rate doesn’t have the desired effect, the BoE raises it again. And it continues doing so, without stopping to consider that maybe what it is doing is not working.
BoE Bank Rate (%) Consumer price inflation rate (%)
Nov 2021 0.10 4.6
Oct 2022 2.25 11.1
Nov 2022. 3.00 10.7
Dec 2022. 3.50 10.5
Feb 2023. 4.00 10.4
Mar 2023 4.25 10.1
May 2023 4.50 8.7
Jun 2023 5.00 7.9
Aug 2023 5.25
A criticism that is often made of the Bank of England is that its staff work in a self-contained silo, pouring over statistics but isolated from the real world. That, and its desire to score well in Stonewall’s league table of good (ie ‘trans inclusive’) employers, might explain the ignorance of biological reality in the Bank’s family leave policy, which defines ‘birthing parent’ as ‘the parent who is/was pregnant with the child but includes persons of any and all genders.” In relation to inflation, its divorce from reality manifests as an unwillingness to countenance any cause of current inflation other than too much consumer demand, and any solution other than raising interest rates.
What is becoming increasingly clear is how damaging higher interest rates have been to an economy that has become accustomed not only to low inflation, but to low interest rates. This encouraged households, believing that interest rates would remain low, to take on large amounts of personal debt. A recent Debt Justice analysis shows that the number of UK households heavily in debt has reached 12.8 million - a 66% increase since 2017, The damage from rising interest rates is felt particularly acutely in the housing market. Here, owner occupiers and landlords who took on mortgages when interest rates were low are hit hard when fixed-rate deals expire. Renters, too, suffer as landlords pass on their higher mortgage costs. But because so many mortgages are paid at rates that are fixed for a period of up to 5 years, the full effects of rising interest rates on many households are delayed, and can continue long after current rates fall.
The impact of an interest rate change is often more immediate for companies. In the food sector, two of the big four UK supermarkets, Morrisons and Asda, have balance sheets heavily loaded with debt, and unexpectedly high interest rates have made it difficult for them to pass cost reductions onto consumers. In water supply, the practice of taking on debt to finance investment, which in the past enabled water companies to boost dividends paid to shareholders, has become a burden. Thames Water is currently close to collapse - other water companies may follow.
Mutual destruction
During the Cold War, the military strategy of Mutually Assured Destruction (MAD) assumed that because both sides would suffer if one side launched a nuclear war, war would be avoided. In the current UK economic situation, different elements of the neoliberal project are at war with each other, and at present nothing seems to be deterring actual destruction. It is, literally, mad.
Unwillingness to curb profiteering has fuelled an inflation which cannot be controlled by raising interest rates. Increased dependence on debt has left consumers and companies alike vulnerable to rising interest rates. And the Bank of England’s unwillingness to learn from its mistakes and change course has left companies which are heavily reliant on debt finance with little option but to continue raising the prices they charge their customers if they are to maintain dividend payments to shareholders.
Raising interest rates in the current context does not counter inflation, it intensifies it. Coupled with continued government insistence on pay restraint, it continues to depress living standards and to run down public services. Notwithstanding a likely short-term recession, boosting economic growth remains the long term aim. But there is now less pretence that this will be ‘green growth’. The cost of living crisis is being used, by politicians in both main parties, as an argument for slowing transition to the decarbonised economy that they relied on to address the climate crisis.