On 22nd June, the Today programme contained an interview with Karen Morgan, an economist who advises the Chancellor and is employed by the financial institution JP Morgan. She gave an admirably honest account of the orthodox view of tackling inflation. In the summary clip here, she states that the aim of Bank of England policy should be to ‘create a recession’ and ‘create uncertainty and frailty’ by raising interest rates.
The essential point is that Bank of England interest rate policy must make people so frightened for their future that they hold onto the money they have and be prepared to accept lower standards of living rather than ask for a pay rise. Businesses should respond to the deliberately created ‘frailty’ by not increasing prices for fear of having no customers left.
Later in the interview, the point was reiterated by stating that you can’t have government programmes to take the edge off mortgage holders’ interest rate pain – because the pain was the purpose of increasing interest rates. The clip ends with a telling phrase used by economists through the ages as they advocate financial pain: ‘there is no other way around it’.
Are there laws of economics?
The clear implication of the ‘there is no alterative’ narrative is that the path of inflation is understood – we are in a cul-de-sac and there is only one safe way out.
You might be surprised to know that there are multiple theories of inflation – notably the Friedman theory which links inflation to interest rates, and the Phillips curve theory which links inflation to unemployment rates. There is also an ‘expectations’ theory of inflation which essentially says that if the right people believe inflation will fall, it will. If you think through the full implications of that, it is truly terrifying. Fortunately, empirical studies which apply these theories to historical data find their predictive power to be very limited. Most forecasters therefore blend a number of these theories to come up with an estimate. Understandably and unsurprisingly, the predictions are regularly wide of the mark.
When you fling an object into space, an understanding of the laws of physics allows us to know with a great deal of accuracy where it will land. However, if you see inflation flying upwards no matter what you do with interest rates, no-one can accurately predict when, where or if it will land.
That is not a criticism of economists. Inflation is caused by the accumulation of decisions made by billions of people in the UK and around the world, so predicting its path with any accuracy is an extraordinary feat. My criticism is that economists and politicians often offer explanations without acknowledging the huge uncertainties while at the same time stating there is no alternative to their proposed solution.
There are sometimes alternatives
JP Morgan was at the heart of the banking crisis. In the aftermath, it paid the world’s largest ever financial penalty of $13Bn for mis-selling billions of dollars’ worth of Mortgage-Backed Securities – the toxic asset class that poisoned the financial system.
The current economic orthodoxy says that markets only work if there is a genuine fear of business owners losing their money. This orthodoxy also states that state interference is to be avoided. JP Morgan’s market capitalisation went from $125Bn in 2009, reaching $200Bn within the next 4 years, and peaked at over $500Bn in 2021. Its existence is owed to the multitrillion-dollar state bailout of the very markets that toxic Mortgage-Backed Securities poisoned, and undoubtedly helped by the $25Bn it received directly from the Federal Reserve Bank at the height of the crisis.
Given the Today programme’s interviewee, this is the most obvious example of a common phenomenon we probably all recognise: that economic truths do not apply to everyone equally. The power of the groups who are being affected matters a great deal. The more power and influence you have, the more flexibly such rules are applied.
It doesn’t matter if it is a rich or a poor person sitting under the tree: when the apple falls, it hits their head just the same. If economic laws were like physics, it wouldn’t matter who they are applied to and who interprets them. But it does.
If economic laws were like physics, they could not be changed; but the way our economy works is changing constantly. It is determined by laws, regulations, institutions, technologies and new ideas, and those changes are not the act of an invisible hand but of deliberate human choices.
When someone says there is ‘no alternative’, what that really means is that they cannot imagine any other choices that they find acceptable. They may be right, but it would be a good idea to ask whose imagination has been brought to bear on the problem and whose views were taken into account when they defined ‘acceptable’.
I am not suggesting some alternate theory of inflation, or even an alternate policy. I am noting that inflexible economic orthodoxy is more easily applied when its most painful consequences are not felt by the people setting the policy. That doesn’t require selfishness or greed – I simply note that the motivation to find creative solutions and to be less accepting of pain is greater when the people who will experience that pain are in the room.
The underlying assumption of increasing interest rates is that across society there is too much money chasing too few goods. Interest rates suck money from the wider economy towards banks, thus reducing inflation. The diagnosis of ‘too much spending power’ may appear plausible in some sections of society, but for those struggling against the rising tide of poverty, such as the people gathered at the ‘Dignity for all‘ conference last weekend, it would be a tough sell.
Attendees might also question the use of the blunt instrument of interest rate rises to suck money from across the entire economy, including the very poorest communities. They might suggest the more precise tool of taxation to reduce spending power. Both have upsides and downsides, but it seems obvious that a JP Morgan banker is going to prefer interest rates over taxation while a single parent whose rent is going to be pushed sky high by rising interest rates would disagree. Why should only one view be in the room where the choice is made?
It seems likely that the next few years are going to see more and more difficult economic choices being made. There will be no shortage of simple, certain explanations, backed by impenetrable, unapproachable maths – and we may be tempted to say it is too hard and just leave it to the experts.
I would argue that that is the last thing we should do. Behind the maths and ill-founded certainty are choices about what we value, what we reward and what a good life together looks like. These are issues that faith groups have wrestled with for millennia and, when it is done well, voices well beyond those of the financial experts are heard. Indeed, they may already be the issues your church thinks about week by week, just using a different language.
JPIT has produced Just Economics, a short study series to begin to expose the moral questions at the heart of the economic system, and help us and our church communities engage with the important choices ahead. You can access the series on our website here.
European Central Bank (2019) ‘Economic Bulletin‘ A pre-pandemic assessment of the accuracy of the bank’s inflation forecasts. Many institutions have done similar exercises with similarly discouraging results.
& Rudd, Jeremy B. (2021). ‘Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?),’ Finance and Economics Discussion Series 2021-062. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2021.062.
A truly beautiful paper from the world’s most important bank that carefully exposes the empirical and theoretical flaws in our current understanding of inflation.
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