Conor here: Richard Murphy delves into the intentions of central bankers as they navigate economic challenges.
By Richard Murphy, Emeritus Professor of Accounting Practice at Sheffield University Management School and a director of Tax Research LLP. Originally published at Funding the Future.
In a recent article in the Financial Times, Megan Greene, a member of the Bank of England’s Monetary Policy Committee, suggested that the UK may need to implement higher interest rates if ongoing conflicts in the Middle East lead to increased energy prices.
Her argument centers around the concern that escalating energy costs could initiate “second-round inflationary effects.” Essentially, this means that as living costs rise, workers might demand higher wages, leading businesses to increase their prices to maintain profit margins. Greene implies that this situation could foster sustained inflation, prompting the Bank of England to intervene through monetary policy adjustments, specifically raising interest rates.
I contend that her perspective is not only misguided but also potentially harmful.
The first point to consider is that an uptick in oil or gas prices does not automatically constitute inflation in the traditional sense. Instead, it results in a shift in relative prices and creates economic shocks as individuals and markets adapt to the rising costs of energy. Such adjustments will undoubtedly leave many individuals financially strained, forced to allocate more of their budget to energy bills and, consequently, having less discretionary income for other expenses. This drop in demand could, in turn, influence prices negatively.
However, this scenario does not parallel a generalized inflationary trend driven by excess demand. Greene’s argument seems to suggest that the Bank of England should intentionally prevent people from shielding themselves from the economic adjustments that may lead to a loss of income. Her reasoning follows that if workers secure higher wages to cope with rising energy expenses, and if businesses pass along these increased labor and energy costs, the cascading effect would extend throughout the economy. Consequently, she argues, interest rates should rise, economic activity should decelerate, unemployment rates should escalate, and bargaining power for workers should diminish, despite actual demand in the economy potentially declining.
This raises a crucial question: does this approach make any sense?
Who Is Responsible?
The primary flaw in Greene’s argument is its assumption that those suffering from an energy shock bear some responsibility for it.
If a conflict in the Middle East disrupts energy supplies, British workers did not create that situation.
Neither did British retirees.
Nor did the British families facing mortgage challenges.
Greene’s proposed response implies that these groups should endure the weight of price adjustments over which they hold no control and for which they share no responsibility. This perspective raises serious questions about economic fairness.
An alternative viewpoint would acknowledge that energy price shocks are fundamentally distributional events. While it is clear that someone must absorb the costs, the critical question is: who will that be?
If energy companies reap increased profits, or if commodity traders or financial markets capitalize on volatility, then there is a compelling argument for intervention to limit these gains or apply a tax on them.
Furthermore, there’s a strong rationale for supporting households whose real incomes have been adversely impacted by factors entirely outside their control.
However, there is no substantial justification for deliberately engineering an economic crisis by raising interest rates—a strategy designed to suppress wages through increased unemployment, which Greene advocates.
The Evidence From Recent Years
The second issue with Greene’s stance is that recent history does not bolster her faith in monetary policy.
The Bank of England raised interest rates significantly starting in late 2021 to counter inflation resulting from temporary supply disruptions due to Covid and from price surges following the onset of the Ukraine conflict.
This led to a sharp rise in mortgage costs.
Business investment dipped.
Economic growth stalled.
Moreover, much of the inflation following Russia’s invasion of Ukraine was expected to recede once energy prices stabilized—a prediction that ultimately proved accurate.
Higher interest rates could not generate additional gas or oil.
They did not restore supply chains.
They failed to end geopolitical conflicts, such as Putin’s war.
The primary effect was the transfer of substantial wealth to those fortunate enough to own financial assets while exacerbating the financial hardships faced by millions of households. This was a policy choice, and it is unclear why repeating this approach would yield improved outcomes now.
The Real Concern
What I find most revealing in Greene’s positing is her assertion that inflation expectations may have heightened sensitivity due to inflation consistently remaining above target for much of the last six years.
This claim has a puzzling circularity. The Bank of England has repeatedly missed its inflation targets, which, I argue, is primarily due to its consistent misinterpretation of inflation drivers. The bank has consistently claimed that inflation was temporary, responding too late and then aggressively tightening policy, resulting in hardship with inflation ultimately tapering off naturally, as history demonstrates it always tends to.
Now, the argument shifts to the idea that because inflation expectations have grown less stable, interest rates presumably should be increased once again. In essence, the solution to previous policy missteps is simply more of the same.
Forgive me if I find this unconvincing.
If current geopolitical tensions escalate energy prices, a more sensible approach would be to identify the specific sources of inflationary pressure and address them directly.
This could entail implementing windfall taxes.
It might require price controls or even rationing in certain markets.
Support for vulnerable households may also be necessary.
Additionally, public investment may be crucial to hastening the transition from fossil fuel reliance.
Every one of these options addresses the root of the issue, whereas raising interest rates does not; it merely redistributes pain.
Ultimately, Greene’s argument illustrates how much of contemporary central banking is ensnared in a paradigm that views unemployment and reduced bargaining power as acceptable strategies for controlling inflation. Its default response is to shift the burden to those least equipped to cope with it while assigning minimal blame to them.
This reflects the power dynamics inherent in traditional economic principles, which often favor individuals already well-off. One might liken it to a bias towards the survival of the wealthiest—an unfortunate reality.
This conventional wisdom, however, reveals a remarkably poor track record when confronting supply shocks, energy crises, and geopolitical tensions.
The lesson gleaned from recent years is not that interest rates should be raised more hastily; rather, it is imperative that central banks exercise greater caution in assuming they can address every issue by making the majority of a nation’s populace poorer through their policies. This is the inevitable outcome of higher interest rates, and that should be recognized.
In summary, if another energy crisis looms, worsening the financial situation of millions is far from a viable solution. It risks compounding the existing crisis rather than alleviating it.
Greene’s proposal does not offer real solutions to our challenges. Instead, it aims to exacerbate existing circumstances during a crisis by inflicting additional, unnecessary poverty through interest rate hikes. Therefore, reining in or even revoking the seemingly independent powers of the Bank of England is crucial for the government. The citizens of this country cannot afford the misguided ideology that Greene embodies.
