As central banks across the world, including the Bank of England, continue to raise the cost of borrowing, the strains on a financial system hooked on a decade of ultra-low interest rates are becoming apparent. Silicon Valley Bank is merely the most prominent example of what could be a string of financial failures and defaults.
Worse, as I argue with my co-authors in a short new book on the cost-of-living crisis, is that the inflation we are experiencing is unlikely to be tamed by interest rate increases, because price rises are flowing from a lethal combination of global instability and profit-maximising monopolies. We are being marched into an economic polycrisis of financial failure, soaring inflation and recession. A comprehensive change in policy is needed to avoid it, in Britain and across the world.
The first step would be to finally repudiate the myth of central bank competence on inflation. The belief that central banks can successfully manage prices, if made “independent” of governments, rests on the 15 years of economic stability before the 2008 financial crisis. The Great Moderation saw inflation level out at low levels across the developed world, and coincided with a fad for declaring central banks “independent” of their governments when making interest rate decisions.
But a far more plausible cause of prolonged low inflation was the massive decline in the real price of manufactured goods as eastern Europe and, especially, China were opened up to global markets. Four hundred million formerly agricultural residents moving into China’s booming industrial cities and factories had more impact than a decade’s worth of “independent” chin-scratching by the Monetary Policy Committee.
Nor did monetary policy exert a notable influence on prices after the 2008 crash, when interest rates were held at near-zero and the great money-printing exercise otherwise known as quantitative easing (QE) began: £895bn of electronic money has been created by the Bank of England since early 2009. Since then, inflation has been variously high, moderate and, on occasion, even negative. There is no clear relationship between QE and the overall level of prices – although its impact on asset prices helped worsen wealth inequality as the Bank of England admits.
The interest rate rises announced today (24 March) will prove similarly redundant – at best. The theory behind raising rates to squash inflation is brutal – which is sometimes openly admitted to by central bankers and their academic friends. It hinges on higher borrowing costs and more attractive savings rates, inducing less spending and so raising unemployment which, in turn, disciplines workers, frightened by the prospect of joblessness, into accepting lower pay rises. Lower pay is then expected to feed into lower prices overall.
This might be thought of as a cruel way to control price rises, if it controlled price rises. The logic matches the government’s rationale for offering derisively low pay rises to its own workers (such as 5 per cent for nurses). But with UK inflation at 10.4 per cent and pay increasing by just 5.7 per cent on average, there is no plausible basis for claiming that higher pay is currently fuelling price rises. The more likely impact from rate increases will be failures comparable to Silicon Valley Bank – an institution whose business model depended on perpetually low interest rates was pushed into a crisis when they rose.
The truth is that inflation today is the unwelcome product of a set of mostly unavoidable global factors interacting with powerful, profit-seeking institutions. The global factors are obvious: Russia’s invasion of Ukraine; the lingering impact of supply chain disruptions from lockdown; and, increasingly, a more unstable global environment that is raising the costs and difficulties of production.
But it is the way shortages and rising costs in essential sectors, most notably energy and food, interact with powerful companies that is decisive – and, potentially, within the control of governments. Though rarely reported as related to inflation, the explosion in large corporate profits over the past year has been exceptional. The extreme profits of the energy companies, made just as energy bills surged, are well known. But profits for food giants have also soared, with the four largest global agribusinesses seeing profits rise by 255 per cent since the Covid-19 pandemic, according to the trade union Unite, while further down the supply chain the UK’s biggest supermarkets have seen a 21 per cent rise in their profits over the same time period. Profit margins for the 350 largest companies on the London stock exchange were 89 per cent higher this year than before the pandemic.
There is no “wage-price spiral”: this something closer to a “profit-price spiral”, as the economists Isabella Weber and Evan Wasner demonstrate in a groundbreaking new paper for the University of Massachusetts. As the pandemic led to shortages, large companies were able to exploit their market power to jam up prices, fuelling inflation and their own superprofits.
With the ecological crisis set to intensify, such shortages will only worsen. That means bigger corporate profits for companies able to exploit them. Our book proposes three solutions to this: the first is increasing payments for all those who cannot rely on wealth – meaning wages, salaries, benefits and pensions all need to rise by at least the rate of inflation, while profits are squeezed. The second is imposing selective price controls on key commodities such as natural gas – a policy lever that is increasingly accepted. The third, over the longer term, is to weaken the grip of major corporations on essential supplies: through investment in alternatives, such as renewable energy and domestic food production, and through the changes in ownership and control that would ensure long-term, sustainable investment in essentials.