A detailed report in the Financial Times this morning lays out the options being considered by new Prime Minister Rishi Sunak and his likely Chancellor, Jeremy Hunt, ahead of the fiscal statement on October 31.

Aside from a hint that Sunak may want to move the date – unlikely, given the close match between PM, Chancellor, and Treasury on the core issue of austerity – there are some further details on the likely headline messages. Intriguingly, this includes:

His plan is likely to appeal to Sunak because much of the fiscal pain will not be felt until after the next general election: it will set out a fiscal consolidation that will aim to have debt falling as a share of gross domestic product in the fifth year.

Parking cuts until after the next general election is what Labour’s then-Chancellor Alastair Darling attempted in 2009 and his final Budget of 2010, after Gordon Brown had been brow-beaten by the Treasury into accepting strict austerity measures. (These were then worsened by Chancellor George Osborne, after the Coalition government was formed in May 2010.)

But the detail on the debt target is interesting. I’d earlier suggested – because it’s an obvious wheeze – that shifting the government’s “fiscal mandate” from having debt falling relative to GDP after three years, to debt falling relative to GDP after  five or seven would significantly reduce the so-called “black hole”. (The “black hole” is entirely the product of the forecasts, and the government’s own fiscal rules: change the forecast, or the rules, or both, and the so-called “black hole” shrinks or even disappears.) It’s difficult, without the official Office for Budget Responsibility forecasts, to know precisely how much more room: but even with higher interest payments on debt, past experience suggests it could be substantial.

It looks like this is what the Treasury is going to go for. The outcome would be to reduce the immediate pressure on the government to cut, and so allow it to palm off any spending cuts until after the election. Combined with “delaying” capital spending, freezing the tax thresholds so that they don’t move with increasing pay, and perhaps even extending a windfall tax – and suddenly the “eye-watering” cuts Hunt threatened last week look less difficult. Cue media plaudits for Sunak’s sound economic management, and a fighting chance for the Tories at the next election.

Trapped

But this also creates a thorny issue for Labour as it draws up its next manifesto. There are already voices from the party’s right urging at least temporary support for austerity, seemingly in the belief that this will make the party look “responsible” in the eyes of some ill-defined group of swing voters, or perhaps just to the Tory press.

The model here is Gordon Brown, who (in)famously stuck to Tory spending plans for the first two years of the Labour government after 1997 – increasing spending fairly sharply thereafter. The belief on the party right is that a period of some pain could be tolerated if it then allowed a Labour government the space to increase spending afterwards.

But this isn’t 1997. Back then, with the economy growing, wages rising, unemployment falling, a comparative squeeze on public spending – miserable though it was – could be masked by rising prosperity more generally. That doesn’t apply this time round. No credible forecast would suggest anything other than a worsening of economic conditions – here and across the world – over the next two years. And of course things could get radically worse: gas supplies in Europe could be seriously curtailed by Russia, a Chinese recession would drag the world economy backwards, the global financial system is creaking and of course the cost of living crisis is unlikely to get significantly better.

It is not even remotely plausible for Labour to think about its next period in office as if the 1990s had never ended. Instead, the party needs an immediate plan for the recovery: delivering serious increases in real living standards – meaning money in people’s pockets – as rapidly as possible: minimum wage increases (I favour £15/hour, in line with party policy); benefits uprated; public sector pay improved. After that, think about what the big investment plans look like. And to make sure the whole thing hangs together, go for serious tax increases on the rich, and hammer out a fiscal framework that gives enough space for a government to borrow, whilst keeping the costs of doing so as low as possible. (A rolling deficit target, over five years, would be preferable to any debt to GDP target.)

It’s not easy. The Tories are likely to recover under Sunak from their current debacle – they would be unlikely to do much worse than present. The British economy is weak, amongst the weakest in the developed world, and the signs from the global economy are worsening. Expectations of change from a new government will be high. Labour’s room for manoeuvre, unlike the 1990s, will be tiny.

The post The Sunak/Hunt plan to ensnare Labour? appeared first on The Progressive Economy Forum.

Very interesting report in the Telegraph this morning, seemingly briefed by the Treasury, on Chancellor Jeremy Hunt’s thinking ahead of the 31 October fiscal statement, billed by Hunt on Monday last week as the occasion for “eye-watering” cuts. Media reports following duly followed in turn, threatening a return to the bad old days of George Osborne, whose earlier, dramatic cuts did so much damage to the economy and social life.

Yet the Telegraph now tells us:

Jeremy Hunt is considering up to £20 billion of tax rises in the Halloween budget, with high earners to bear the brunt of his quest to balance the books.

The Chancellor has been told by the Office for Budget Responsibility (OBR) that there is still a £40 billion black hole in the nation’s finances, even after he axed almost all of the mini-Budget.

He is looking to raise as much as half that amount from putting up taxes, reducing the need for painful and highly controversial cuts to public spending…

George Osborne, when implementing the austerity measures of the David Cameron years, favoured an 80-20 split of spending cuts to tax rises.

Mr Hunt is believed to feel such cuts are no longer viable, and has had Treasury officials exploring options for a divide as even as 50-50.

The cynical might have suspected some earlier expectations management at work here: without seeing the official Office for Budget Responsibility forecasts, it’s a little hard to judge, but somewhat better than expected growth figures combined with some tweaks to the fiscal rule would clear a fair chunk of the so-called “black hole” in the public finances. (The sacking of Suella Braverman last week appears to have been the product of a row between her and Liz Truss over immigration policy. The OBR model is set up to produce better growth forecasts with higher immigration forecasts – which means if they expect the regime to be looser in future, it would give higher growth forecasts. For example.)

The “black hole” is a product of the forecasts and the government’s own target to shrink the debt. Change the forecasts, change the target, and the black hole shrinks. If Hunt is seriously considering various wealth taxes there are some comparatively low-hanging fruit even for Tories, like the various tweaks the Telegraph suggests to capital gains tax.  It wouldn’t be too difficult to remove the “black hole” without the bloodcurdling cuts Hunt has implied are necessary. Filling it becomes even easier if the Tories are prepared to lift taxes on the rich. If the remainder is filled with cuts to capital spending – like new public transport, or energy infrastructure – the immediate impacts of the cuts on most of us will be minimal.

By telling us how bad things are going to get, and then winding back, Hunt and the government can hope to minimise any resistance and win media plaudits for his skilful economic handling. This expectations management.

Don’t be gulled by this. There’s no case for cuts to spending and, after a decade of cuts, very little room where any additional spending can be removed. Cutting back on capital spending, after it has already been whittled away, contributing to the economic weaknesses of the last decade, would be longer-term disaster: we urgently need new capital investment in energy production and low-carbon technology, as well as spending on increasingly essential defences against extreme weather and other climate-related disruptions – like the flood defences foolishly hacked away at in a previous round of austerity. The biggest single “saving” Hunt has so far announced is restricting the Energy Price Guarantee to just six months – meaning, on current forecasts, the typical household will be facing a £4,3000 annual energy bill in April next year as the Guarantee expires.

The government can get through the immediate, short-run crisis with some goosing of the figures and leaning a little more heavily on the wealthy than it has done in the past. It’s a sign of their weakness, relative to the 2010s, and the unpopularity of spending cuts that they have to work like this. But for the longer term – even just for the next few years – we urgently need more spending across the public sector, from investment in renewables to putting health, education and social care back on their feet. Now is the time to raise our expectations, and to demand more from the main political parties, not to tug our forelocks in gratitude that the cuts weren’t quite as bad a kindly Mr Hunt first threatened.

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The Governor of the Bank of England, speaking at an IMF conference yesterday evening:

Bank of England, as reported before breakfast this morning:

In between time, the pound had done this:

Modern central banking is mostly about the communications of modern central banking. Take former European Central Bank president Mario Draghi’s declaration that he would do “whatever it takes” to save the euro, in 2012. Did Draghi actually have to do “whatever it takes”? No, just declaring clearly and credibly that he would was enough to end the speculation around the terms of the euro’s disintegration and immediately improve financial condition in the eurozone and beyond.

What Bailey and the Bank of England have just done is the exact opposite.

Confusion

So why the confusion? Why the mixed messaging? The Bank’s fundamental problem, beneath whatever it wants to tell the world, is that its two major objectives now contradict. The Bank of England, like any central bank, has a primary task of ensuring financial stability. This is why central banks exist at all, in their modern form: central banks emerged as a “lender of last resort” for a currency’s banking system, meaning it was known by all other banks, financial institutions, and their customers, that the central bank was ready to step in and preserve the system’s stability if needed – by issuing emergency loans to failing institutions, for example.

Their second function, inflation targeting, emerged only very much later – really in the last few decades or so. Although much better-known today, inflation targeting by central banks is only possible because of their fundamental role in trying to preserve financial stability. By acting as the fundamental support for the whole monetary system, central banks develop great powers over the system. The interest rate central banks pay on the bank accounts the commercial banks hold with them grows to exercise a control over interest rates in the system more generally. When the Bank of England or some other central bank is reported to be adjusting “the” interest rate, this “Bank rate” is the rate it is adjusting. The idea is that by the central bank changing the interest rate paid out on its own reserves, every other bank and financial institution will adjust its own interest rates. (The Bank of England has a clear explainer here.)

Under normal circumstances, these two functions work together. The Bank of England’s Monetary Policy Committee (MPC) meets monthly to set the Bank’s main interest rate, aiming to keep inflation at the government’s target level of 2%. The Financial Policy Committee, meanwhile, keeps an eye out for future financial crises and potential instability. After the 2008 crash, the MPC has also overseen the massive programme of government bond-buying called “Quantitative Easing” (QE), taking decisions on the value of government bonds the Bank should buy with freshly-issued Bank money. Novel in early 2009 when it was introduced, for good or ill QE is now an accepted part of most central banks’ policy toolkits. Again, this has all been accepted as normal, innocent central bank behaviour – even when QE was expanded by some £400bn to cover the costs of covid in 2020. At the start of September, the MPC announced it would be reversing QE with “Quantitative Tightening” (QT) – selling government bonds back to the financial markets – as part of its effort to control inflation, alongside increasing the Bank rate.

Normal

Alas, the times are not normal, and haven’t been for a while. Kwasi Kwarteng’s mini-Budget on September 23rd, containing £45bn of additional borrowing (on top of the Energy Price Guarantee) and including an unexpected new tax cut for the wealthiest, sparked an almighty panic amongst those in financial markets. The pound fell rapidly in value against other currencies and the price demanded by traders for lending to the British government – the “gilt rate” – shot up. This sudden change in the gilt rate in turn seems to have destabilised British pension funds, who had, over the previous decade or more, developed sophisticated ways to try and match up the payments they make to pensioners with the earnings they receive from their assets. These techniques, collectively known as “Liability Driven Investment” were sophisticated but, it turned out, fragile if market conditions changed rapidly. By Monday 26th, there was a risk that some pension funds faced insolvency and therefore of much wider market disorder.

The Bank of England, as the situation worsened, moved on Wednesday 29th to operate its primary function: preserving financial stability, promising up to £5bn-worth of additional bond-buying a day for the next 13 working days, and ending Quantitative Tightening.

But notice that this is a screeching reverse of the earlier decision to start QT to combat inflation. The Bank’s aim of preserving financial stability runs directly counter, right now, to its aim of keeping inflation low. The same tools and instruments are being used to try and do two, contradictory things. This contradiction by itself would be a decent reason for the Bank to try and impose a time limit on the extra support it has offered, and was (presumably) the reason for setting that limit. But without the pension funds magically managing to reorganise themselves at very short notice – and the picture here is unclear – the time limit just delayed the inevitable, currently set to arrive on Friday morning.

This contradiction is the reason for the confusion at the top of the Bank. But the confusion should alarm all of us. The Bank of England has been the most important economic institution in the country for the last decade. Time and again its interventions have enabled an otherwise weak economy to steer through a series of crises, from Brexit to covid, with relatively little damage. If the Bank is now itself starting to look as dysfunctional as every other major institution, we are collectively in a very bad place. And it is absolutely not a good look for the governor of a central bank to say one big, important thing and then have himself immediately contradicted by his own bank a few short hours later.

Chicken

What to do? There might be ways for the Bank to try and manage this mess more effectively. Steven Major, HSBC’s head of global research has suggested they should make clear the financial stability intervention is only buying long-term bonds (which it is), whilst the monetary policy intervention (“Quantitative Tightening”) is only selling short term bonds (which it is). These are two different parts of the market and two different financial products, so – in theory – two different interventions could be applied. Major goes on to suggest that the Bank rate could still be used to signal the Bank’s intentions about inflation, with Bank rate rises (expected to be steep over the next few months) continuing.

Perhaps more fundamentally, as former Permanent Secretary to the Treasury Nick Macpherson has said, it isn’t actually the Bank’s job to bail out pension funds. That falls to the government – the Bank was only bounced into intervening as it became apparent, barely two weeks ago, that a general failure of pension funds had bigger market implications. That would mean the Treasury pulling together a rescue package for the funds, which, one way or another, means adding still further to the government’s rapidly rising pile of debt and more pressure on interest rates. One, possibly generous, reading of Bailey’s behaviour is that he has thrown down the gauntlet not so much to pension funds as to the government: that either the Treasury will have this mess resolved by Friday, or the Bank will not be responsible for the consequences. (You may think it’s a bad sign that a central bank is playing chicken with its own government, and you’d be absolutely right.)

So a quick, relatively low-cost resolution to the current mess would be for the government to U-turn on whatever remains of the Budget, although plausibly this would end Kwasi Kwarteng’s political career; the slower, higher-cost resolution would involve a government backstop for failed pension funds, although this might allow Chancellor Kwarteng to remain in Number Eleven. It’s a dilemma: who amongst us can truly say which of these options is best? Most likely, of course, is some fudge, whereby the Bank declares and end to the current round of exceptional support, but then cunningly reintroduces something quite similar looking for Monday morning whilst the government continues to chisel away at its own mini-Budget.

Either way, the resolution would only be temporary. The cost of government borrowing has been forced upwards, to heights unheard of even a few years ago, and is unlikely to come back down much in the future. The pound continues its long-term decline. The economy is shrinking as we slide into a probable recession. If we get right down to the fundamentals, Britain is a weak, unproductive, low investment, low wage, high debt economy with a massive dependence on imports for essentials like natural gas and food. It has run off fumes for much of the last decade, leaning more and more heavily on the historic reputation of its core institutions – like the Bank of England – to maintain a semblance of progress. But there are limits to how much the Bank can do with monetary policy, and the Truss government has cack-handedly exposed those limits in the last few weeks. Things are only likely to get worse, and potentially much worse, from this point onwards.

The post What is the Bank of England playing at? appeared first on The Progressive Economy Forum.

The main rate of inflation in the UK, the Consumer Price Index, fell from July’s 40-year peak of 10.1% to 9.9% in August. This reflects the impact of sharp declines in the global price of oil over the summer, which fed into the falling price of motor fuel. However, food prices are continuing to rise, and the increasing price of food made the biggest single upwards contribution to the overall figure.

The graph below, from the Office for National Statistics, shows the impact – excluding food and energy price rises from the overall figure would bring the reported rate of inflation down by about 4%.

It’s worth stressing that this general picture is the same across the globe: the surge in oil and gas prices, pre-dating Russia’s invasion of Ukraine (see the graph below), and the very rapid rise in food prices are common everywhere. The graph below shows the same measure of inflation across the G7 economies. The common experience is obvious, although Britain is the worst-affected by the rise:

It’s likely, although not a given, that oil and gas prices will continue to fall over the next few months, easing pressure on inflation significantly. (Goldman Sachs has a particularly optimistic view of this, expecting natural gas prices to “tumble” across Europe in the next few months.) In the UK, the energy price cap, to be introduced by government to limit the October increase in typical domestic energy bills to £600 is forecast, by government, to take 4% off the expected rate of inflation over the end of the year. Some of the predictions of a 20% or even higher inflation rates look less likely to come true – though subject to substantial uncertainty, not least around events in and related to the Russia-Ukraine war.

But this doesn’t mean the great inflationary surge is over. Far from it. There are two points to bear in mind. First, inflation is cumulative. If the rate of inflation today is lower than it was last month, that doesn’t mean prices in general are falling. It means the overall rate of increase is less fast. Those higher price rises are likely to be permanent – prices went up 10.1% in the 12 months to July, and went up 9.2% in the twelve months to August. They’ve not actually fallen. Unless incomes from wages, salaries, benefits and pensions rise rapidly, those high particularly high prices earlier in the year will represent a permanent loss to most people’s living standards. And prices, bear in mind, are still rising.

Second, inflation is unlikely to settle back down to the 2% or so level it has been at for the last two or three decades. The reason for this has less to do with the explanations usually offered, around wages being too high (if only!) or there being too much money in the system. It has to do with the way in which our global, money-based economy responds to continued environmental shocks. Many economic activities are getting harder to undertake, as the environment we live in changes. Extreme weather events are becoming more common. Resources, whether mineral or agricultural, are depleting, pushing up prices. Recent shocks to the food supply include:

• South Africa’s biggest locust plague for 25 years attacked farms in the eastern part of the country in April 2022, following “Biblical” plagues across East Africa in 2020. The worsening outbreaks are thought to be linked to increasingly volatile weather conditions associated with climate change;
• The Environment Agency forecasts that extreme heat in 2022 is will reduce UK production of “carrots, onions, sugar beet, apples and hops” by 10-50%;
• Europe’s “worst drought for 500 years” is forecast to reduce output for maize by 16%, soybeans by 15%, and sunflowers by 12% compared to the average for the last five years.

Some of the impacts of climate change can be quite unexpected, like extreme heat drying out the Rhine and so restricting goods transport across Europe, pushing up the price. But whatever the source, or the specific impact, these environmental shocks keep happening, pushing up the real costs of economic activity. In a global economy dominated by credit money, this translates into rising inflation – increased costs becoming rising prices which then pull more money into circulation.

This has, notably, nothing to do with wages: in fact, faced with shocks like this, the best thing to do in the short term is insist wages must rise to compensate, with profits adjusting to carry the strain of reduced outputs and higher costs, rather wages and household incomes. Wealth, rather than household incomes, can act as a better short-term shock absorber and when British companies have over £950bn stashed in their bank accounts – up  £500bn from 2010– there is no good reason to not put that money to better use. In the long term we need far more resilient energy, food, and transport systems – something likely to start with on-shoring production and the switch into renewables.  

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The IMF reports that inflation globally continues to be driven by rises in the price of food and energy:

Food and energy are the main drivers of this inflation… Indeed, since the start of last year, the average contributions just from food exceed the overall average rate of inflation during 2016-2020. In other words, food inflation alone has eroded global living standards at the same rate as inflation of all consumption did in the five years immediately before the pandemic.

They show the breakdown of the contribution of both to global price rises on their “Chart of the Week”, as below:

Whilst inflation in other sectors (the IMF economists pick out service prices in the US) has picked up a little, it is overwhelmingly the impact of price rises in two essentials that is responsible for the rise in prices felt across the world. And because these two are essentials, with few options for substitution in either for most of us – everyone has to eat! – their combined impact on living standards is being keenly felt across the globe.

That squeeze on living standards, in turn, translates into falling sales of non-essential items. As prices for things we pretty well have to buy increases, those on lower incomes across the world – which is to say, almost everyone – are reducing what they spend on things they can choose to buy. If, as in Britain, your household energy bill has gone up £1,000 in the last few months, there are limits to how much you can plausibly reduce that consumption, especially with winter in the Northern Hemisphere approaching. People have been cutting back on expenditure elsewhere – for instance on going out for meals, or Netflix subscriptions. The price rise is, in other words, inducing a fall in demand and therefore pushing economies into recession. The National Institute of Economic Research reports Britain is already in a recession, and the US and other advanced economies are widely expected to follow suit.

This is not, according to the standard model of the macroeconomy, what is supposed to happen, or how inflation is supposed to operate. The standard models depend, critically, on inflation appearing as a result of changes in demand. If total demand for goods and services is pushed above what the economy can supply – if, for instance, the government borrows and spends a great deal of money – inflation will rise as firms chase that additional spending with price rises, rather than expanding output.

But what we can see now is something like the opposite of this process. Rising prices of specific goods and services, where consumption isn’t an option but a necessity, is causing falling demand for other goods and services as consumer shift their expenditure around. Inflation isn’t occurring from demand factors, but from changes to the supply of critical goods and services.

This has important consequences, the most obvious of which is that the usual mechanisms to regulate demand will no longer work, or at least be very limited in their impacts. Raising interest rates, as many central banks are now doing, is intended to dampen demand in an economy, since borrowing becomes more expensive (and saving more desirable). But if inflation is arriving as a result of supply shocks, changing demand won’t do much beyond perhaps pushing up unemployment. For the Bank of England and other central banks to be pushing up interest rates now risks creating “stagflation”: a recession, combined with high rates of inflation.

Traditional demand management no longer effective

The flip side of this is that, if policies to restrict demand have little impact on inflation so, too, do policies that stoke demand up. In the standard model, for the government to propose (as the British government did last week) to borrow around £150bn more than it planned, and to use this as a subsidy to household consumption (in this case, by keeping domestic energy prices lower than they would have been) would normally stoke up inflation a great deal. This time, the expected effect is likely to be exactly the opposite: any extra cash earned by households will simply compensate them for the loss of disposable income from rising energy prices, rather than adding to their earnings. Overall demand will be returned to where it was (almost) without the price hike. And since the spending is intended to cut domestic energy prices, inflation will automatically be reduced as a result – perhaps by around 4%.

The usual rules of “demand management”, in other words, do not apply in a world with idiosyncratic shocks to supply of the kind we’ve been seeing – and will continue to see in the future as the environmental crisis worsens. The implication is that government interventions against the operation of the market are likely to become more, not less, frequent in future. When price spikes are extreme, as we’ve seen in energy prices, they start to call into question the functioning of the market system itself – if the expected 80% rise in UK domestic energy prices had been allowed to go through entirely, the shock to demand in the rest of the economy would have been disastrous. Price controls, once utterly taboo in polite policymaking circles, are coming back into favour as a result.

The post Global inflation still driven by food and energy prices. Recession is the likely result. appeared first on The Progressive Economy Forum.

There’s an unpleasant calm before the storm feel to British politics at the minute. Anyone who remembers the period from the end of 2006 through to the debacle of autumn 2008, with the failure of Northern Rock as a half-way point, will be familiar with the sensation: of watching an increasing number of the proverbial warning lights start to flash.

This isn’t, however, a repeat of 2008. (In critical respects, it’s worse – a more fundamental malaise.) Back then, from around 2006 onwards, multiplying defaults in the US housing market were amplified by the complex financial products the same mortgage debts had been packaged into, and then traded between major global financial institutions. Over 2007 and right up to the 15 September 2008 bankruptcy of Lehman Bros, these highly leveraged packages of debt were exploding and bringing down larger and larger financial institutions. By autumn that year, the crisis had spread into the dead-centre of the financial system: the giant, world-spanning investment banks, headquartered in the larger developed economies on both sides of the Atlantic, which now faced bankruptcy. Lehman Bros was allowed by the US government to fail; the shockwaves from the overnight disappearance of one of the world’s largest investment banks were so great as to then mobilise panicked support from the world’s major-economy governments. Various packages were rapidly assembled and, by spring 2009, the Bank of England and the US Federal Reserve had embarked on unprecedented money-printing exercise of Quantitative Easing. (Although sometimes presented as a crisis of “Anglo-Saxon” capitalism, or some similar story about the more risk-taking and unstable US/UK version of capitalism, major European banks like Credit Suisse and Deutsche Bank, had seriously overreached themselves.)

Crucially, the mechanism of crisis here was “endogenous”- meaning it was generated primarily inside the financial system itself. It was a classic debt bubble, as described by Hyman Minsky and others, that was bursting. The years of stability over the 2000s had encouraged the taking of more and more risks by financial institutions in the belief that the bubble would never best. But, as in Minsky’s description of the mechanism for crisis, stability generated later instability: the “Minsky moment” occurred when just a few of those debts could not be repaid – in this case, it was the US “subprime” mortgages that defaulted first – and this wobble was amplified by the huge amounts of debt that the earlier period of stability had built up. That financial crisis was then pushed into the wider economy – a sharp retrenchment of lending leading to less spending which, in turn, pushed economies rapidly into recession.

IMF warnings

This time round, the mechanism is (mostly) running the other way: that succession of disruptions to the real economy might provoke a financial crisis which would act as amplifier for the disruption, but not itself operate as a trigger. In addition, the regulations and additional support for financial systems that have been put in place since 2008 have reduced the presence of “systemic risks”, or at least reduced the systemic risks of the kind that played a crucial role in 2008. The system has been subjected to one, immense shock, when covid first erupted in spring 2020, and, whilst there was a brief wobble in financial markets across the globe, nothing like 2008 recurred.

This doesn’t mean there are no financial risks, with the IMF’s latest Global Financial Stability Report highlighting rising leverage (indebtedness) in corporate and household sectors across the world, the weakly-regulated space of cryptoassets, and the unevenness of the recovery from 2020-21 between the advanced and “emerging market” economies. The latter is already producing strains. Sri Lanka, hard hit by covid, is facing shortages of “food, fuel and medicines” and is heading towards a default on its government debt. The government has approached China and the IMF for additional support, with China already offering a $1bn “swap line” of cheap credit – this arriving on top of the $3.5bn its government already owes to Chinese concerns.

One specific risk highlighted by the IMF across “emerging markets” is a version something that was already seen inside the eurozone in the aftermath of the 2008 crash: the “sovereign-bank nexus” turning rotten. With governments borrowing more, it has been banks in the global south who have loaned the money, leaving them with huge amounts of high-risk government debt on their balance sheet. Should a sovereign default, those banks themselves are at risk of failure. This could lead them to (at the very least) reign in their lending to households and businesses, provoking a recession – and then of course bringing the risk of sovereign default that much closer. Coupled with a slowdown in global trade, and the tightening of monetary policy in the advanced economies, particularly the US, which squeezes export markets for the less-developed world, and makes lending into the less developed less attractive, and the stage is set for an economic slowdown followed, in some cases, by default.

This is a relatively familiar story – one that fits easily into our existing ways of understanding economic crises. Either (as in 2008) a financial crisis causes a shock to demand, provoking recession, or a shock to demand provokes a financial crisis, worsening recession. In both cases the mechanism operates on the demand side. (This, incidentally, is what made austerity such a perverse response to the crash: a crisis driven by a collapse in spending was to be countered by… further cuts in spending.)

Supply-side crisis

Instead, the coming recession is emerging primarily as a result of supply-side factors. The rise in inflation, at least for the large, advanced economies in the OECD, is appearing because of rising import prices of essentials like oil, gas and food. It is not the product of “excess” domestic demand – retail sales are falling in the UK, but the prices paid by consumers are continuing to rise. And then there is the impact of concentration in different industries, enabling mark-ups on goods to stay high, and the hoarding of wealth, particularly of housing wealth: whilst consumers have seen their real incomes squeezed hard by rising prices, many large corporations have enjoyed a bumper few years. House prices, meanwhile, continue their upward march, assisted by the production of vast quantities of new, Quantitative Easing money since early 2020.

In all these cases, the causality runs from supply-side disruptions, led by covid-19, now joined by Russia’s invasion of Ukraine and, increasingly, by extreme weather across the world, that then feed into a grossly unequal distribution of ownership and finally turn into a squeeze on most people’s purchasing power as prices rise faster than their incomes. Throw in, on top of that, rising debt – in part as a result of attempting to maintain purchasing power, but itself turning quickly, via rising repayments, into a squeeze on spending – and the stage is set for a significant downturn in the UK and other advanced economies over the next 12 months.

This may not, as in the textbook demand-side recession, produce huge increases in unemployment, at least in the UK, where the “flexible” labour market has enabled the explosion of bogus self-employment, zero hours contracts, and other more insecure forms of work since 2008. We might well anticipate that if real wages are falling (since prices are rising faster than wages), the incentive for employers will be to maintain existing employment, or at least moderate their attempts to reduce costs by making redundancies. But seeing millions of people maintained in increasingly precarious employment, forced to cut back on their own spending as prices continue to rise, would hardly be a good thing.

The short-run solutions depend on two things, neither of which this government seem willing to achieve: rapid increases in wages and salaries, over and above the rate of inflation, and restrictions on price rises in key goods. Rapid increases in public sector pay, and the National Living Wage, both of which the government can control, would induce pay rises across the rest of the economy. Capping energy price rises in October – which, again, the government can determine – would significantly ease pressure on households. Down the line, a restructuring or simple write-off of unpayable household debt may well prove necessary, freeing up additional consumer spending. A short-run programme of rapid redistribution, from capital to labour and from creditors to debtors, would help get over the immediate hump. In the longer term, a more fundamental shift is needed – away from increasingly expensive non-renewable sources of energy and into cheap, domestically-generated renewables, matched to a programme of efficiency improvements such as providing proper loft insulation.  

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Overshadowed by the appalling news from Ukraine, Chancellor Rishi Sunak presented the annual Mais Lecture in London a couple of weeks ago. Traditionally used by Chancellors (and, sometimes, Shadow Chancellors) as a space to fill out the detail of their economic plans, and (they hope) give the impression of some depth of thought behind them, this was, as other commentators have pointed, out a comparatively rare insight into Sunak’s mind a few weeks of what will be, for him, another Spring Statement severely rattled by external events.

Battered by the pandemic, and subject to the whims of a once all-powerful Prime Minister, Sunak has spent two years in office cranking up government spending whilst offering variations of St Augustine’s prayer: “Lord, make me fiscally conservative, but not yet!” Mais Lecture was no different in this respect, once again promising the faithful that he would soon, very soon, start cutting taxes.

And of course you have to read the whole thing through a potential Conservative Party leadership battle. It helps to read British politics in general through the prism of a never-ending Tory leadership contest: like other semi-democracies, squabbles amongst factions in the ruling party matter far more than debates between the ruling party and the tolerated opposition – whatever the likelihood of any actual changes at the top.

But with Liz Truss letting her Tory MMT tendencies be known early on, judiciously making sure news of her indifference to deficits was leaked to the Times just ahead of Tory Party Conference last year, Sunak had to establish some clear blue water on the question of spending. Truss wants to cut taxes, regardless of the impact on government borrowing. Sunak “firmly believes” in low taxes but is “disheartened… by the flippant claim” that taxes pay for themselves. Tut tut. Once again, low taxes, but not yet.

What’s more striking is, as per usual, what Sunak doesn’t talk about. For a decade Tories noisily insisted that the government debt and the government’s deficit were the most important problem in the world, and that all other government spending could be sacrificed to shrinking both. Former Chancellor George Osborne used his own Mais Lecture to spell out the argument for immediate action on government spending, back in 2010. Osborne offered a cogent and closely-argued case for finding the poorest and most vulnerable in society and fiscally waterboarding them for a decade.

Never mind that the gurus he cited, Kenneth Rogoff and Carmen Reinhart, turned out to have made a spreadsheet error in their calculations on the impact of government debt on growth which rendered their most eye-catching claims useless. And never mind, too, that by the time he left office, Osborne had overseen the longest decline in living standards since the dawn of industrial capitalism, even as the government debt burden continued to rise. What matters here is the intellectual framing of the discussion around the role of government in the economy as entirely negative: that government, with its shocking debts and yawning deficits, was little more than a deadweight on a long-suffering private sector, yearning to be free.  Aided and abetted by a compliant media, who didn’t know better, and the Institute of Fiscal Studies, who should’ve known better, the economic illiteracy of the story mattered less than its political purpose in justifying the reshaping of the British economy back around the interests of its financial system in the years after the 2008 crisis.

So tightly were austerity’s mind-forged manacles that it took the triple shock of Brexit, Jeremy Corbyn and covid to break them. Brexit gave us a Tory Prime Minister who wanted to talk about the “burning injustices” of the economy. Corbyn, in turbulent years after the 2017 election, gave us a different Tory Prime Minister who consistently increased spending. And covid has given us a Tory Chancellor who scarcely references the government debt.

The contrast between Osborne and Sunak, then, is stark. The current Chancellor reflects a new consensus, apparent across the business press in recent months, that government spending in the future is going to be higher: on (his words) “health, pensions and social care” for an ageing population; on the “legacy of covid” in annual vaccination programmes, antivirals, and testing; on education; on government infrastructure investment, praised by Sunak; and of course on the military, where demands have been raised for a 25% increase in the current budget.

This isn’t the austerity economics of the 2010s. It is a higher-spending, bigger-state Toryism that means, come 2024, the difference between the two main parties’ spending plans – widening in elections 2015 onwards – is likely to be substantially reduced. Reduced, too, will be their rhetoric on the fundamentals of the economy: both accept a significantly increased role for government investment, including on renewable energy; both accept the need for  intervention in the economy to address inequality, beyond using the tax system alone (aka “Levelling Up”); both accept the idea that intervention can address the productivity problem. And both have decided to foreground economic growth as the key to a successful economy.

Market morality

It’s here that Sunak gets interesting, once we get past the boil-in-a-bag Treasury policy prescriptions for growth. Sunak wants to cut taxes on investment by businesses, invest more in “adult skills”, and spend more on R&D – so far, so familiar, although Sunak at least throws in the possibility of scooping up “entrepreneurs and highly skilled people” from all over the world, post-Brexit.

Instead it is when Sunak tells us about his desire to create a “new culture of enterprise” that we should be paying more attention. Sunak’s carefully-curated public image has been of a man somewhat wary of big ideas and book-reading (“all my favourite books are fiction”), but it is to Adam Smith he turns to make the link between culture and economic growth: not via the Wealth of Nations, but its forerunner, the Theory of Moral Sentiments: that a free market not only ensures outcomes that are economically efficient, but that markets themselves are grounded in morality, Sunak here referencing the late Jonathan Sacks’ own Mais Lecture. The process of market interaction itself (says Sunak) shapes morals and therefore culture. “Moral responsibility,” he claims “can only come from being exposed to the consequences – whether good or bad – of our own actions.”

This isn’t a conventional, libertarian-inclined defence of the free market, often associated with the Wealth of Nations, in which freely-transacting individuals are magically guided by the “invisible hand” to produce the best possible outcome for society. This “invisible hand”makes no claims about the morality of your choices, simply that everyone’s preferences will be met best if we allow it do work its mysterious magic. Sunak says this is reading Smith wrong: “Smiths account of the market economy, is not as some have suggested a values free construct which rationalised social choice.”

But this argument for market morality is also not quite that of Sacks’ original Mais lecture, which was a slightly more conventional take on how free markets, desirable as they for producing economic growth and productive cooperation, also require stable social institutions: family, religious organisations, community groups, and so on. We get on with our social interactions, the market sorts out that section of them we call the economy, and the greatest happiness of the greatest number is ensured. We learn our morals and “habits of cooperation” in “the domain of families, congregations, communities, neighbourhood groups and voluntary organisations”.

The invisible hand of Sunak, on the other hand, has a decidedly morally interventionist streak. We will have better moral characters if we allow a market-type process of rewards and punishments to shape them, facing the “consequences… of our own actions”. Happily, the shaping of our characters in turn shapes a culture which then creates the conditions for economic growth through the “universal and laudable desire to better the condition of ourselves and those we love”. A free market fosters an “enterprise culture” which will, in turn, make Britain more receptive to economic growth delivered by a succession of terrific new technologies, lead by Artificial Intelligence (as always).

Note the firm limits to “laudable” bettering here, and what it should be aiming for; and whilst Sunak identifies the need for government to provide some minimum level of support where needed, the boundaries for government action are constrained. Whereas Sacks suggests that economic growth, engendered by the free market, is just one part of a what makes a good society, and that this culture provides the necessary foundations of the market, Sunak’s rather darker argument is that the desirable culture is one that produces growth, and that market outcomes themselves are crucial to shaping that culture.

Sunak may talk up economic growth. He suggests he is an optimist on its future. But if the growth pessimists he cites are right, we left with only the moral claims. What he establishes here looks more like the moral and intellectual framework for a low-growth and significantly more authoritarian version of capitalism.

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The Financial Times front page this morning splashes on reports that China is dropping its studied neutrality over the Russian invasion of Ukraine:

China signalled it was ready to play a role in finding a ceasefire in Ukraine as it “deplored” the outbreak of conflict in its strongest comments yet on the war.

Beijing said it was “extremely concerned about the harm to civilians” in comments that came after a phone call between Chinese foreign minister Wang Yi and his Ukrainian counterpart Dmytro Kuleba.

“Ukraine is willing to strengthen communications with China and looks forward to China playing a role in realising a ceasefire,” the Chinese statement said on Tuesday.

It added that it respected “the territorial integrity of all countries”, without indicating whether Beijing accepted Russia’s claim to the Crimean peninsula or shared its recognition of separatists in the Donbas region of eastern Ukraine.

First signs of this emerged a few days ago, as China’s Ministry of Foreign Affairs shifted its neutral tone on the conflict to stress the importance of “sovereignty” in comments to foreign journalists.

China’s central role here shows the way in which power in the world has shifted over the last decade. The US, Canada and European countries, later joined by Japan, took exceptional economic measures against Russia over the last week. These have been described as unprecedented in their scope, taking action against oligarchs, banning some Russian banks from using the SWIFT banking service, and imposing restrictions on Bank of Russia, the Russian central bank.

But the real importance of these measures sometimes gets confused. Blocking SWIFT, the interbank messaging system, has been talked up as a deadly blow to the Russian economy. It certainly adds costs and difficulties to doing cross-border business with Russia and for Russian institutions, but it’s not an economic knockout. SWIFT isn’t a payments service – it’s a system designed for banks to communicate with each other about the payments they wish to make. It could be replaced with phone calls or faxes.: a nuisance, but not critical.

Jamie Dimon, chief executive of JP Morgan, made the same point in interview two days ago:

He said the move to limit Russian access to the Swift banking network might have a lot of workarounds, meaning it wouldn’t alone stop sanctioned parties or others from doing business. The Swift network is the main messaging system banks use around the globe to conduct cross-border transactions. Mr. Dimon said blocking it doesn’t mean alternative messaging systems are blocked as well.

“A sanction says I cannot do business with you,” Mr. Dimon said. “A Swift thing says I can’t use a communication [tool] to do business with you. I can still do business with you.”

Similarly, sanctions against oligarchs and the networks of criminal financing that they use – flowing in vast sums through London and its associated tax havens – will cause difficulty and nuisance, and plausibly could help turn those closest to Putin against him. But it’s in the category of nuisance – potentially serious nuisance – for the mega-rich, rather than a fundamental blow.

Central bank sanctions are decisive

The deadly warhead in the sanctions is the ban on trading Russia’s central bank reserves. The joint communique from the US, Canada and the European powers says:

[W]e commit to imposing restrictive measures that will prevent the Russian Central Bank from deploying its international reserves in ways that undermine the impact of our sanctions.

Russia will be barred from selling its central bank assets on global markets, where those assets are held in a participating country, or are being traded by an institution or an individual in a participating country. This has left Bank of Russia unable to support the rouble by, for instance, selling those assets to buy roubles (as it was doing until the ban came in force).

And it means that many Russians will assume that both their roubles are worth less, and their banks are at risk of collapse, sparking bank runs – as we have seen. The response of the central bank has been to whack up interest rates to 20%, and to impose various restrictions on taking currency and assets out of the country  – most recently, it has banned moving more than $10,000 in foreign currency out of Russia.

Central banks are the lynch-pin of a modern economy, defending the stability of the banking system and (therefore) its currency. Control over a central bank gives a hostile power immense leverage. We saw this in the eurozone crisis, when both Ireland in 2010, and Greece in 2015 were threatened with the collapse of their national banking systems by the European Central Bank, if they did not sign up to stringent austerity measures. Both were brought rapidly to heel.

The sanctions being put in place today are an unprecedented economic weapon applied by the joint powers to the Russian economy. The chaos they have produced is all too evident, the rouble falling, for a while, to an all-time low against the rouble. There are suggestions that financial markets across the world are exposed to the risk of default and economic failure in Russia, but of course the people suffering their effects most right now are ordinary Russians. They are the most effective weapon in the joint powers’ economic armory.

Russian defences against economic sanctions

Crucially, however, the sanctions leave assets not held in the joint powers’ currencies, or in their jurisdictions, outside of their scope. The Bank of Russia’s reserves come to $640bn – a veritable war chest that has been built up, very deliberately, over the last decade or so. Russia squeezed its domestic economy and ran huge current account surpluses which, in turn, enable the central bank to acquire these reserves.

But at the same time, Bank of Russia has been getting our of dollar and dollar-denominated assets, precisely in anticipation of something like this ban being applied. It now holds only $bn of US Treasury bills, massively down from the all-time high of $176bn in October 2010.

Jon Sindreu, in the Wall Street Journal, has a breakdown of the Bank’s holdings today, in a piece noting the holes in the sanctions regime:

The two largest components are gold and renminbi-denominated assets. As the caption notes, both of these are “likely safe from being blocked by the West”. It’s difficult – arguably increasingly difficult – for even the Federal Reserve to try and bar sales of renminbi assets outside of US financial institutions. Gold, playing the role it has for millennia, is a uniquely tradeable store of value. Russia holds its gold physically inside the country, and – if it can arrange physical transportation, or offer credible guarantees of its future delivery (big ifs!) – this is a viable reserve for exchange.

That leaves China. And this is where the essential leverage of China comes in. Both countries have been building up trade and other economic relations for some time, agreeing a strategic cooperation with “friendship… that has no limits” just ahead of the Beijing Olympics. Since sanctions were imposed on Russia in 2014, trade between the two countries has grown more than 50% and China is now Russia’s biggest export destination. China and Russia agreed a thirty-year contract for gas supplies just ahead of the invasion.

This is a lifeline for Russia right now. But it is also a pressure point, and potentially a decisive one. Europe gets 40% of its natural gas from Russia. This is way the gas trade with Russia is not sanctioned. China’s demand has been growing, but Russia still supplies just 5% of its domestic consumption. China could apply leverage here. Russia’s remaining non-gold central bank assets are renminbi-denominated. China could try to control their use. Or, in both cases, plausibly threaten to do so.

We are a long way from the Cold War: the balance of the world does not hinge on decisions in Moscow and Washington, or even Paris and London. They depend on Beijing.

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Latest inflation figures from the Office for National Statistics put average price rises in the 12 months to September at 4.2%, its highest rate of growth since November 2011. Back then, a post-financial crisis surge in prices pushed inflation to above 5%, and it stayed high until mid-2014 when OPEC’s decision to maintain oil production helped bring down prices across the globe.

Whilst last year’s lockdowns and subsequent recessions kept inflation very low, as we would expect – with spending falling dramatically, there is little to no pressure to raise prices – reopening since earlier this year has coincided with a dramatic rise in prices. Despite some optimistic claims that this would be “transitory” shift in prices, dependent solely on the unusual demand conditions caused by reopening, nearly 12 months it is harder to sustain the view.

Some of this is due to Brexit, which even prior to Britain’s exit from the EU had pushed domestic inflation up as a result of the fall in the value of the pound, relative to other currencies, after the 2016 referendum. But most of it is from the bigger impact – global, even – of covid-19. Developed countries across the world are seeing similar combinations of supply chain stresses, shortages of key goods, rising energy prices, and higher inflation.

The big question in all this is whether these price rises will fade away as the initial shock of the pandemic wears off – perhaps stretching out into next year, but not much further – or whether they will become entrenched, moving us into a permanently higher inflation regime.

Incorrect models and tighter monetary policy

More conventional Keynesian economists would be far happier with a temporary surge in prices, since the usual belief is that price rises register an economy that is “overheating”: too much demand chasing too little supply and that (therefore) governments should either cut their own spending, raise taxes or, if they are unwilling or unable to do either of those two, to raise interest rates. So persistently high inflation tends to lead to demands for interest rate rises – which, of course, are now starting to happen. Central banks’ own mandates are typically, in this era of their “independence”, modelled on the “Taylor Rule” linking interest rates to inflation, with rates increases mandated as inflation also rises. The Bank of England avoided this temptation at last month’s rate-setting meeting of its Monetary Policy Committee, but the voices demanding a tightening of monetary policy are getting louder.

Latest in this growing chorus is the Financial Times’ widely-read chief economics commentator, Martin Wolf, who sees today the first glimmerings of a return to the 1970s: “as price rises became more general and real wages were being eroded, workers became increasingly militant. Finally, a general wage-price spiral became all too visible.”

Under circumstances where strike numbers in Britain remain close to their lowest since records began, where union membership in the private sector is amongst the lowest in the developed world and – crucially – where average wage growth has been near-zero for a decade, a “general wage-price spiral” should be the last concern anyone has right now. Frankly, a little more “union militancy” would be good for the economy – pay rises would pull back on skyrocketing inequality, and put more money into the hands of people who are more likely to spend it.

But Wolf, instead, sees the problem of pay rises as being one in which inflation can move from being merely “transitory”, driven by exceptional post-lockdown circumstances, and moves into a permanent or at least long-run problem. He cites US economist Jason Furman as noting a tightening of labour markets, with “seven unemployed workers for every 10 openings”. Rattling around in people’s heads is the idea that, if pay rises are won by workers, these will turn into firms putting up prices, causing further demands for wage increases, and so forcing firms to raise prices again, and so on. This is the “wage-price spiral” Wolf refers to.

But the evidence from the last decade is that the British labour market, at least, has not been functioning like this. From mid-2014 onwards, as the OPEC “reverse oil price shock” worked its way through the global economy, inflation has consistently undershot both forecasts and the Bank of England’s own target – and this despite ultra-loose monetary policy of near-zero base rate and huge Quantitative Easing. Austerity, and the public sector wage freeze, certainly played its part, undermining the ability of those seeking work or in employment to bargain for higher pay. But so, too, does the “flexible” labour market, especially after 2010, with its mass creation of deeply insecure, low-paid work like the notorious zero hour contracts.

A model of the economy that didn’t include this extraordinary undermining of labour’s bargaining position – that instead assumed something closer to the labour market institutions of the 1970s were still in place – would be one that persistently overestimates inflation. This happened in the 2010s, and, to the extent that people think a wage-price spiral is a realistic possibility, and blame inflation on it, I think it’s happening again today. And to the extent that this leads to inappropriate calls for monetary policy tightening, it will cause problems today, too.

The real causes of persistent inflation

However, Wolf and others are right to worry about inflation becoming persistent, even if the mechanism they imply isn’t quite there. One part of this is the argument made by Charles Goodhart and Manoj Pradhan about demographics: that the exceptionally loose labour markets of the last forty years, the product of two enormous one-time expansions of the global labour force as China and Eastern Europe were integrated into it, are now tightening as this demographic exception approaches retirement. There is no second China out there. There will be no further loosening of labour markets in the future. And so wages, and – in their argument – prices and interest rates will finally start to rise.

It’s an interesting (and intuitive) argument that, incidentally, calls into question some cherished beliefs about the role of central bank “independence” in promoting low inflation over the last two decades or so. And for those with one eye on inequality, it holds out the possibility that the great shift in power towards capital and away from labour that characterised the neoliberal period may finally be coming to an end. This would, of course, over time move us back towards a kind of 1970s world, with higher inflation, higher interest rates – but also, potentially, stronger worker organisation able to win higher pay and better conditions, just like Wolf and others think already exists.

But the other part is significantly less positive. What Wolf calls “special factors”, citing the “surging price of gas” are likely to become less special over time. If there’s a disconnect between some conventional macro modelling and the reality of how labour markets have behaved in the last decade or more, there’s an even bigger disconnect between macro modelling and the reality of environmental decay. As a point of construction, conventional macroeconomic models tend to assume that, whatever is happening today, strong forces in the economy will pull it back to a stable growth path in the long run. But for this to happen, the conditions for growth to occur must themselves be stable. When all our environmental models are saying (for example) that extreme weather events, crop failures and disease outbreaks are all going to become more frequent, the assumption of environmental stability no longer applies.

So if (for another example) there is a frost in Brazil that has damaged coffee production, helping drive its price up to a seven year high today, that is a one-off shock that we would expect to fade away over time – prices would rise once, but the impact on inflation would disappear, since inflation measures price increases over time. But this seemingly one-off, specific environmental shock will be followed by other, similar shocks in the future, most likely at an increasing frequency: more droughts, more frosts, more wildfires and so on. The result will be a sustained increase in costs and prices: or, in other words, higher inflation.

It’s environmental breakdown that we should be worrying today’s inflation hawks, not the possibility of workers winning pay rises. And the prescription for dealing with this kind of ecological ratchet on prices is the exact opposite to the hawk’s usual package: not interest rate rises, but low rates to encourage investment and expand supply – particularly targeting ecological investment, as the People’s Bank of China is now doing. And not panic about rising wages but an insistence that the costs of ecological decline should be borne fairly, with pay increases across the board – paid for out of profits and interest as needed.

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Good news as the Bank of England’s Monetary Policy Committee (MPC) voted to once again hold its base rate steady at 0.1%. This comes a day after the US Federal Reserve Board, the equivalent rate-setter for the US, voted to also leave rates untouched.

After months of warnings that a rates rises was imminent, with inflation now well above the Bank’s 2% target, this was a wise decision by policymakers. As the Bank’s governor, Andrew Bailey, has previously pointed out, with inflation coming in from the shocks to supply over the last 18 months or so, there is little fiddling with interest rates can immediately do:

In considering how to use monetary policy, it is also important to understand the nature of the shocks that are causing higher inflation. The shocks that we are seeing are restricting supply in the economy relative to the recovery of demand. This is important because monetary policy will not increase the supply of semi-conductor chips, it will not increase the amount of wind (no, really), and nor will it produce more HGV drivers. Moreover, tightening monetary policy could make things worse in this situation by putting more downward pressure on a weakening recovery of the economy.

He’s absolutely right: interest rate rises would do little to dampen the inflation we have today, but would hurt the economy more generally. But this didn’t stop Bailey making hawkish noises over the last few months. Nor did it stop the Bank’s new chief economist, Huw Pill dropping very substantial hints to the FT that he was minded to push for rates rises.

Nonetheless, by a 7-2 vote the MPC’s great and good – which include Bailey and Pill – have decided to hold off on interest rates, no doubt helped along by the Fed’s decision. Not everyone is happy. Some of traders lured into thinking they had a one-way bet on Bank of England rates rises have been whinging to the press, claiming that Bailey’s “credibility” would now be on the line.

Pressure will be on the MPC to shift rates upwards at their December meeting, since it is wholly unlikely that inflation will be coming down any time soon. But it must be resisted: the far bigger risk to the Bank’s “credibility” is, as Charles Goodhart and Majoj Pradhan have argued, if the Bank decides to incrementally raise interest rates but fail to materially influence inflation – as it surely would do.

Bailey has let it be known that rates rises will be heading down the line “in coming months”. But if the logic of holding steady today – that inflation is the result of supply factors, not demand – the same will hold in a few months’ time. For those who take a pessimistic view of likely future supply constraints, the same will hold at any point in the foreseeable future.

Interestingly, the Bank itself also looks increasingly pessimistic. Its forecasts for damage from covid-19 have been revised upwards, to the (in my view, still far too low) level of a 2% permanent loss to GDP from the virus, up from 1% and matching the Office for Budget Responsibility’s assumptions. And the Bank’s view of supply growth in the medium term is low, set at 1.75% as compared to 2.75% it has been estimated as in the decade before the financial crisis.

As this reduction in potential growth suggests, the economic slowdown had happened before covid. What seems likely (although the Bank do not yet accept this) is that covid, alongside the growing frequency of extreme weather, crop failures, and further disease outbreaks as the planet’s climate changes will all turn into hard barriers to supply growth (and therefore long-run growth overall) in the near future. Either way, its short-run forecasts for growth have been revised down for the next four years, hitting just 1.1% growth by 2024 (Table 1.A).

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