Who Pays for Higher Interest Rates?

Tightening monetary policy is not without consequences. When interest rates are increased, the countervailing impact on prices is achieved through higher unemployment, as the result of less credit creation and lower demand for goods and services. Any deflationary result won by these policies will come, at least in part, from suppressing the living conditions of workers. Economist Paul Krugman famously quipped that anyone who thought that increasing the money supply would cause inflation without also increasing aggregate demand was committed to a belief in “immaculate inflation.” Similarly, we could say that thinking that tightening the money supply will lead to the opposite results, without further consequences, entails belief in immaculate deflation.

Andrew Bailey, the governor of the Bank of England, made clear that these consequences would have to be borne by workers. The day after the hike, he offered some unusually candid remarks when he said that “we need to see a moderation of wage rises.” “Now that’s painful,” he added, but it is what is needed in order to prevent inflation from becoming entrenched.

This is an old hat. Politicians and central banks often justify destructive anti-inflationary policies by front-loading concerns for the finances of small households and pensioners. It is undeniable that living costs have risen sharply, driven by the relentless increase in the cost of housing and services. But we should be careful to understand what politicians and the media have termed the “cost of living crisis” within the context of Britain’s long-term economic decline.

Real wages remain below the level they were before the 2008 financial crisis, and prospects for an economic rebalancing in the interests of workers remain bleak. Real post-tax labor incomes (earnings after taxes and adjusted for inflation) are expected to fall a further 2 percent this year and not recover until 2024. The crisis is as much about this shortfall of earnings as it is about rising living costs. It is not obvious how further wage deflation helps to address this.

There are, in addition, other ways in which in which the decision to raise or to signal raising rates is incoherent. The price increases seen now have nothing to do with excessive wage demands. They are instead driven largely by pandemic-induced convulsions in global supply chains and energy markets — themselves the results of decades of rampant corporate avarice and monopolization leading to outsourcing and the generalization of the very “just-in-time” logistics upended by the pandemic. Arresting price increases owed almost exclusively to supply issues by raising interest rates not only shifts the burden to those least responsible for it; it is also nonsensical.

It is analogous to administering an antibiotic to fight a viral infection: it won’t help, and the patient might expire.

Beyond these obvious contradictions, it’s not even clear that current price movements constitute “inflation” in any meaningful sense. The movements have been too particular, too sectoral. They don’t reflect that broad-based decrease in the purchasing power of money. They are not driven by sustained wage increases that are feeding through to prices.

Firms Set Prices, Not Workers

It is worth remembering that prices are set by firms. And labor costs are only one component of prices. Bailey thought it necessary to call on workers to moderate their wage demands, rather than cautioning businesses about the inflationary risk of stabilizing their profits at any cost. Such a request comes after a decade of tolerating rapid asset price inflation, driven in part by the bank’s policies. The message seems clear: price controls are fine, but only for labor. The governor’s comments therefore seem to signal that the object of monetary tightening was not merely to ensure central bank credibility, but workplace discipline.

The recrudescence of tight money will have other repercussions. When monetary policy was still ultra-accommodative in the wake of the Great Recession, borrowing costs for government, firms, and households plummeted. The results have been more debt, both in absolute and relative terms. As it stands in 2022, the stock of global debt is estimated at about $295 trillion, at just around 355 percent of global GDP.

The global interest bill clocks in at about $10.2 trillion. It is hard to assess the impact of steadily higher interest payments; it depends on how much of the debt has a fixed interest rate attached to it and the length of the average maturity of these debts. But in Britain, 25 percent of mortgage debt is variable, while in countries such as Norway, the share is twice as high.

It is a rare event for a globally concerted tightening cycle not to induce a recession. In this case, it might choke off an already muted recovery. Outside of the United States — which managed to enact a massive fiscal stimulus — the growth has proven tepid and unsteady, with demand dampened by stagnant household incomes, and supply still constricted by tangled distribution chains. All in all, this is not the time to abandon low rates.

The call for wage moderation is at odds with the stated policy of Boris Johnson’s conservative government, which has pledged a “high wage and high growth” economy. Meanwhile, the highest strata of financial capital has called for restraint when it comes to fighting inflation, with two executives of the giant asset manager BlackRock voicing their concern over premature tightening in the pages of the Financial Times. With their plans, then, central banks are putting themselves in a strange place: well to the right of usually inflation-averse conversative politicians and asset managers.

Economist Dario Perkins wryly remarked: “We should have a race. The first central bank to crash their economy with rate hikes wins a prize.” Britain seems to have given itself a head start.