November 7, 2022   5 mins

When the Bank of England announced its single biggest interest rate hike in 33 years last week, and warned that the UK faces its longest recession ever, it forgot to mention one important detail. It’s the actions of the Bank itself that are setting the country on the path to full-blown depression.

Anyone with a basic grasp of economics knows that raising interest rates at a time of recession is bound to make it worse. Borrowing will become more expensive, while mortgage holders will face higher monthly bills — and all the while, the country is grappling with a devastating cost-of-living crisis.

Officially, the Bank’s actions are aimed at curbing inflation. But this approach would only make sense if the current inflation were being driven by excess demand — that is, if people had magically found themselves flush with cash and had started splashing out. Alas, anyone living in the real world knows that’s not the case: two years of lockdowns and restrictions have left many people poorer, not richer.

Only last month, a study by Bank of England staff confirmed what was obvious to most people, but apparently not to the researchers’ bosses. Current inflation has nothing to do with excess demand, but is largely driven by exogenous, supply-side factors: “supply bottlenecks along global value chains due to the Covid-19 pandemic (for instance, with microchips and used cars) and soaring energy and food prices related to Russia’s invasion of Ukraine”. Other studies have also emphasised the role of corporate profiteering, in particular, price gouging by large corporations with near-monopolistic market power, especially in the energy sector.

Neither is there any evidence of a Seventies-style wage-price spiral. On the contrary, real wages are not only failing to keep up with inflation — they’re falling off a cliff, in the UK and elsewhere. That’s because the bargaining power of workers has been severely weakened by decades of anti-labour and anti-union policies.

Even the Bank of England itself acknowledges that it expects inflation to fall sharply from the middle of next year — even below its target of 2% from late 2023. The reason is fairly obvious: inflation measures the change of prices from one year to the next, so this year’s rate accounts for the massive price increase caused by the conflict in Ukraine. Next year, however, prices are expected to remain relatively high, but not to rise significantly compared to current levels. In other words, we’ll almost certainly still be facing a cost-of-living crisis — especially if the Bank of England continues along this path — but not much of an inflationary crisis.

So if the current inflationary bout has nothing to do either with excess demand nor excessive wage increases, but is in fact driven by factors entirely beyond the control of the Bank of England, and in any case is expected to resolve itself by the beginning of next year, why is the Bank going out of its way to pursue a strategy that would lead to a recession and raise unemployment, and make the cost-of-living crisis even more acute?

One possible answer was alluded to by Andrew Bailey, Governor of the Bank of England, last week: “We have inflation coming back down to target; and going below target actually,” he said. “But we have one of the largest upside risks to inflation in our forecast that we’ve had in the 25-year history of the Monetary Policy Committee. A lot of that has to do with the tightness of the UK labour market.”

Such “tightness” — that is, the fact that there aren’t enough available workers to fill vacant jobs — is currently driven mainly by Brexit and by the fact that since the pandemic a great number of older workers (mainly 50- to 64-year-olds) have left the job market. But it is likely to become a permanent feature of Western economies in the coming years — a result of the de-globalisation and reshoring that will inevitably see countries bring home production lines and supply chains that over the past decades have been outsourced to far-flung countries. For Western workers, this is a welcome development, as it will clearly increase their bargaining power.

But for Bailey and the technocratic elites he represents, this is a terrifying prospect: even though workers aren’t yet strong enough or sufficiently well-organised to fight for better wages, a structurally tighter labour market is liable to make such struggles much more likely in the future, especially in a context of permanently higher prices. They fear this not because it might lead to a wage-price spiral, which is unlikely, but because it would signal a shift in the labour-capital balance for the first time in half a century.

As Adam Tooze has written, what really worries technocrats like Bailey “is that inflation will emerge as a macroeconomic and, one might say, a macrosocial phenomenon. All of that is code for a world in which organised labour is stronger and in which workers receive not gratuitous handouts from socially minded employers to help with the grocery bills, but proper cost of living adjustments”. This is about more than just capitalists having to give workers a bigger share of the pie: a more emboldened labour force is also more likely to start demanding a greater voice in the management of their country’s economic and political affairs — a technocrat’s worst nightmare.

According to this view, bringing about a recession and artificially raising unemployment could be seen by the likes of Bailey as a way to pre-empt a potential rise in labour bargaining power — not only by making borrowing harder, but also by providing a cover for fiscal austerity, which Sunak has already announced. This isn’t because higher interest rates make it any harder for the government to borrow from a technical perspective — a currency-issuing government can ultimately service interest payments in the same way it pays for everything else: by issuing new money via the central bank. Rather, higher rates give the impression of making it harder for the government to borrow, due to the myths we’re constantly fed about deficits and debt. As Larry Elliott has observed: “The idea that Britain is about to be sucked into a vortex because it is running a budget deficit is a fairytale. A country that has its own currency, as the UK does, can print money to cover its spending.”

Maintaining that fairytale, however, is crucial from the perspective of the ruling class — if citizens understood how the system really worked, they would realise that austerity is nothing more than class war. In this sense, as political economist Richard Murphy put it, the Bank of England shouldn’t be seen as operating independently of the government in pursuing these policies. On the contrary, the Bank is likely “working very closely with the Treasury to create this artificial supposed public spending crisis”.

Bailey and Sunak aren’t alone in pursuing this project. Central banks across the globe are all raising interest rates — with the US Federal Reserve leading the way. And most governments are using this to justify austerity, to some degree or another.

Now, it is often claimed that if the Fed raises interest rates, other central banks have little choice but to follow in order to avoid capital flight. But this is only partially true. Allowing the value of currencies to slide — as most of them are against the dollar, not just the pound — is arguably a better option than engineered recession: the former might lead to higher imported prices, but the latter will cause much more widespread damage, without even resolving the problem of inflation. Besides, it’s unlikely that driving economies into recession is going to bolster “confidence” in their respective currencies — unsurprisingly, the pound slumped once again against the dollar after the Bank of England’s warning of an impending depression. So much for the Bank ousting Truss in order to save the economy. That said, if other central banks were being forced into these policies against their will, we’d expect some criticism of the Fed’s aggressive monetary tightening on their behalf, and yet we’ve seen none of that.

What this really calls into the question is the notion that we need “independent central banks” to protect us from irresponsible politicians. If anything, it’s irresponsible central bankers that we need protection from. But for as long as central banks and governments are able to shift the blame onto each other, the technocrats will always have the upper hand. So, perhaps the time has come to slay the dragon — central banks themselves. A possible solution would be to consolidate monetary and fiscal policy into a single government department. At least this would make macroeconomic policy wholly accountable to voters, instead of being managed by central bankers who are largely unaccountable and dominated by vested interests. The past month has proved that technocracy has failed. The time has come to give democracy a chance.

Thomas Fazi is an UnHerd columnist and translator. His latest book is The Covid Consensus, co-authored with Toby Green.