With inflation surging to 7 per cent on the consumer prices index, we’re approaching a moment that mainstream economic policymaking is unprepared for: when a mixture of debt and rising living costs leaves both the government and the central bank without levers to pull.
Global energy and food prices, which were already rising because of post-Covid shortages, are now soaring due to sanctions against Russia. Interest rates on government debt, which have been low and falling for decades, are spiking in the UK and across the world.
In the UK, with inflation predicted to peak at 8.7 per cent by the end of 2022, a mixture of tax rises and falling real wages means the average British household will endure the biggest fall in living standards since records began in 1956-57.
Since the 1990s, when central banks took over the running of national economies, the tool for fighting inflation was simple: squash growth by raising interest rates. But for 30 years, due to a mixture of globalisation, de-unionisation and technological innovation, inflation wasn’t much of a problem – so interest rates generally remained low.
After the 2008 financial crisis, central bankers had to improvise a new tool to stave off deflation. Quantitative easing, whereby the central bank creates money to flood the financial system with risk-free cash, was designed as a temporary lifeline to the private sector. But it has become capitalism’s iron lung: neither the Eurozone, the UK, the US, nor Japan could function without monetary life support.
In the meantime, we live off debt. On the eve of the global financial crisis, the sum total of household, government and corporate debt stood at $147trn – just under twice the size of today’s global GDP. Before the Covid-19 pandemic it stood at $197trn. Prior to the Ukraine war, it stood at $226trn – which is 256 per cent of GDP. In the process, here and elsewhere, the central bank itself has begun to directly finance government borrowing.
Russia’s invasion of Ukraine, and the unprecedented sanctions imposed by the West, have increased the interest rates paid by governments, while central banks are forced to hike the rates paid by the rest of us. So the cost of living and the cost of borrowing are rising simultaneously, while growth is faltering.
If you’re Rishi Sunak, the economics textbook tells you to cut public spending and raise taxes. If you’re the Bank of England governor Andrew Bailey, the textbook tells you to raise interest rates. It also tells you that leaving £895bn of quantitative easing money floating around the system is a bad idea, while removing it is also a bad idea.
The result is policy paralysis. Beyond the farce of partygate, Boris Johnson and Sunak are at odds over something fundamental: Johnson wants to go on borrowing and spending money – to boost defence, to spray billions at Red Wall constituencies, to build new nuclear power stations. Sunak, meanwhile, wants to shrink the state and balance the books. The Bank of England, meanwhile, will be forced by its mandate to raise interest rates harder and faster, even as people’s real incomes plummet.
What we’re seeing, at a deeper level, is a clash between ideology and reality. During the neoliberal era, the illusion grew that the British economy could be regulated towards a steady state through the semi-automatic management techniques of fiscal and monetary policy. Do the right thing, with taxes, borrowing and interest rates, and the right result should occur, even if the young are priced out of the housing market and jobs are insecure.
Now we’re in a hurricane – one driven not just by wild economic forces but geopolitical ones. Energy insecurity, the climate crisis and economic warfare (because that’s what sanctions amount to) are like 50-foot waves hitting the ship of state from all directions.
One thing is certain. Left to the neoliberal diehards, all solutions will hammer the working class. To pay for defence spending, they will cut money for welfare and council services. To bear down on inflation, the Bank of England has demanded workers suffer an effective pay cut. The cost of greening the energy system, says Sunak, must be borne by this generation, through higher taxes, not the next through borrowing. As food and energy prices spike due to the Ukraine war, it is ordinary families who must struggle to pay the bills.
To find solutions we need to reach into a different toolbox – that of the wartime Keynesian economies of the 1940s. We already have weak energy price controls in the form of the price cap, which has risen from £1,137 before the pandemic to £1,971 today and is set to rise further. But because it is driven by global prices, and the need for gas suppliers to make profits, it cannot protect households effectively from the storm. In its place we are going to need a more comprehensive system of price controls: on food, energy and housing costs.
Price controls are usually associated with wartime – but in the UK, in the late 1960s, there was a comprehensive attempt at both wage and price control. In the US, partly due to the absence of a genuine welfare state, there are partial price controls on household energy, medical bills and rents.
Price controls work like this: the government sets an official retail price, or band of prices, for the essential goods that households cannot live without. For example, the state would fix the price of a basket of essential food items, household energy bills, rent and monthly mortgage repayments. The question then is: who absorbs the difference between the global market price and the price paid by the consumer? The answer is either the taxpayer or the corporate sector – and since debt is already high, and taxes will be needed to fund the energy transition and welfare measures, the main burden will fall on companies.
The explicit aim of a progressive price control regime, even if it only covers energy, rent, food and public transport, is to depress profits and raise real wages. If you find yourself outraged by that proposal, just reverse it and see how it feels. By doing nothing, in a period of high inflation and high interest rates, the government boosts profits and cuts wages. It’s a straight choice.
But price controls are only one way the state can intervene. It can, for example, boost the real wages of public sector workers. Comprehensive state ownership, in the case of energy and public transport, is a simpler answer than trying to coerce a bunch of artificially created private monopolies into price restraint. Likewise, one reason we don’t need price controls in UK healthcare is because the NHS provides it for free. Making some goods – such as local bus journeys, all dentistry and, as Labour proposed, broadband internet – free at the point of use is another way to bear down on inflation while boosting social justice.
Labour, at present, is trapped within the logic of a busted fiscal and monetary policy system that cannot respond quickly or effectively enough to the new global situation. One-off windfall taxes have their uses, but a comprehensive rethink of how the state operates the economy is what’s really needed. That, in turn, requires convincing millions of voters that radical change is needed. The only way to do that is to start talking about it.