Having failed miserably to achieve its inflation target in the short term, medium term and now long term, the Bank of England has come up with a new plan to solve the inflation problem once and for all. And it is a cunning plan, as some might say. The plan to deal with inflation is… to simply accept it.
Well, they want you to accept it, anyway.
Now, 10% inflation might not seem ideal to you and me. And simply accepting it might seem a bit difficult to stomach. But that’s no reason to demand a 10% pay rise, raise your business’ prices by 10%, or demand the Bank of England’s wages, benefits and pensions are frozen.
No, acceptance of inflation is the key to solving it. You just need to pretend it isn’t happening and the problem goes away.
Chief economist Huw Pill announced this new monetary policy tool on a podcast. It was such an absurd idea that even the BBC reported on it:
Somehow in the UK, someone needs to accept that they’re worse off and stop trying to maintain their real spending power by bidding up prices, whether through higher wages or passing energy costs on to customers.
What we’re facing now is that reluctance to accept that. That pass-the-parcel game that’s going on here, that game is one that’s generating inflation, and that part of inflation can persist.
Somehow, someone needs to accept they’re worse off? I hope Pill has a licence to give such financial advice.
I’d also like to question whether this is in line with the Bank of England’s policy mandate. Is the Bank really supposed to manage inflation by telling people to be poorer and accept it?
Anyway, if you ask me, the comments aren’t just a bitter pill to swallow. They’re also economically wrong.
Raising your wages and prices in line with inflation does not contribute to inflation. It merely keeps pace.
Furthermore, suggesting that wages are what’s behind inflation is a bit odd given wage growth is lagging very far behind inflation indeed.
In fact, it was the worst year since 1977 by that measure. Sky News prefers the technically correct version of the worst since “since records began” in 2001. Either way, if wages were driving inflation, it would be half the current rate. Instead, wages are not even keeping up with inflation. Most people are actually following Pill’s advice and accepting that they are poorer, rather than demanding wage increases to keep up with inflation.
Central bankers have a very poor record on this issue. Their claim that rising wages cause inflation has been disproven so often that only economic theory can uphold the claim. They call that theory the Phillips Curve.
Pill’s colleagues in Australia, who promised not to raise interest rates until wages began rising, were caught out by this fallacy too. Inflation soared well before wages. And now the Reserve Bank of Australia (RBA) is in for some serious reform after it was forced to hike rates in response.
Could it be that rising wages are in fact a symptom rather than cause of inflation?
Funnily enough the RBA recently discovered it has been systematically underpaying its staff for years. This can be punishable by a decade in prison in Australia… in the private sector.
Back to the Bank of England’s cunning plan for your wages. Apart from not demanding wage increases to keep up with inflation, chief economist Huw Pill would also like people to spend less, thereby pushing up prices less. Which is a typical thing for a macroeconomist to say.
Now, I don’t know about you, but I’d find it difficult to decrease the amount of food in my grocery shopping. I’d also find it difficult to increase how much food I buy, but that’s probably not relevant here.
The point is that food purchases are price inelastic. How much food we buy doesn’t depend much if at all on prices. We need to eat about the same amount. What changes is how much of our income goes to such essentials. And how much is left over to spend on other things.
If food prices go up, alongside the prices of other essentials, then how much we spend on non-essentials inherently falls. It’s a self-regulating system.
So, when Pill is asking us to spend less, he is effectively asking people to eat less in order to bring down food prices so that the Bank of England can meet its inflation target. Which seems to put the cart before the horse, if you ask me. And then flog it for not moving.
Now, obviously, if the price of oranges were going up 10% while the price of apples fell 10%, Pill would have a point. He could ask people to stop buying as many oranges and start buying more apples. But inflation is a broad-based price measure. It is the general cost of living.
In fact, it is a measure of the general devaluation of money, not the rising price of everything. When inflation goes up, it is money that has changed, not the apples and oranges we buy.
Asking people to buy less misses this crucial point, which goes right to the heart of the matter. It is also the lesson we thought Pill had learned about six months ago, when he admitted central bank policy choices were a cause of our inflation. Has he forgotten it?
I’m happy to explain…
If inflation is a monetary issue, who controls the value of money? Well, the Bank of England controls the amount of base money which gets pumped into the economy by quantitative easing and tightening. It controls the interest rate on money too, at which it is lent into existence by banks. And it helps to oversee the banking system which manages the financial system.
As a result of all this power and control, the Bank of England has a legal mandate to manage inflation, with a target of 2% year over year.
You don’t. I don’t. Our neighbours don’t. The people whom Pill is asking to buy less and accept their poverty don’t have the mandate to manage inflation either.
Pill and the rest of the Monetary Policy Committee do. And not by asking us to behave like we’re poorer.
Indeed, given their failure, you might think that they should be the ones who should accept being poorer. In the form of being fired.
Here’s the strangest part of the whole drama. Pill wants companies to avoid raising prices, because this will feed inflation too. Instead, businesses need to accept lower profits. But as you read his own explanation of the logic behind this, you might notice something:
The UK, which is a big net importer of natural gas, is facing a situation where the price of what you’re buying from the rest of the world has gone up a lot, relative to the price of what you’re selling to the rest of the world, which is mainly services in the case of the UK.
You don’t need to be much of an economist to realise that if what you’re buying has gone up a lot relative to what you’re selling, you’re going to be worse off.
If the price of what we import has gone up, but what we export hasn’t, and this is the source of our ills, then the obvious solution is… what? That’s right, raise the prices of what we export – precisely what Pill has told us not to do!
The idea behind this solution is what’s known as the neutrality of money. If all prices in the economy, including assets, debts, wages and all contracts, were to rise by 10% tomorrow, that would mean inflation, but it wouldn’t make anyone worse off. Because everything has shifted together, the effect on most of us would be negligible. Only those with large cash balances relative to incomes and assets would miss out.
In reality, inflation is bad because its costs and benefits are unevenly distributed. Those who don’t get the 10% pay rise, those who can’t raise prices easily, those who own investments that aren’t inflation linked and those who have floating rate mortgages are in trouble. Those who have inflation-linked investments, fixed-rate mortgages, gold and wages linked to inflation are largely immune. Inflation redistributes wealth.
So, when the Bank of England is telling people to accept that they are poorer, he only means some people. And those some people should not try to recover the ground they lost relative to others because this would make inflation worse?
And this coming from the chief economist of the Bank of England which is charged with managing inflation? Marie Antoinette may have suggested that the poor, lacking enough bread, eat cake instead. But at least she wasn’t in charge of the mill, or the bakery.
It sounds like blackmail to me…
If you don’t stop buying groceries to keep the price down, we’ll hike your mortgages (and thereby the rent your landlord charges) to the point you’re forced to choose between food and shelter. That’ll solve the problem!
If you’re sick of this bizarre and mismanaged financial system, at least you now have a choice to escape. Find out what it is, here.
Nick Hubble
Editor, Fortune & Freedom
