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3 November

It’s time to stop kidding ourselves the Bank of England can control inflation

Only the government can administer the required medicine of subsidies and price controls.

By James Meadway

The Bank of England’s Monetary Policy Committee (MPC) has today chosen to push the rate of interest it controls to 3 per cent – the rise of 0.75 percentage points is the largest sustained leap in its base rate for three decades. The reason it gives for the increase is that a painful but necessarily sharp adjustment is needed to try to pull inflation back down to the Bank’s target level of 2 per cent.

The move will undoubtedly be painful, particularly for those on variable-rate mortgages, and risks a longer and deeper recession as consumers pull back on spending. But as an attempt to control inflation, it is wholly and completely misguided – the result of a collision between the Bank’s pre-millennium mandate, designed for a calm world of steady growth and stable prices, and the darkening economic and ecological times of the 21st century.

The inflation we’re experiencing today isn’t the result of anything the Bank of England plausibly influences. There’s no interest rate it can set in London that will end the war in Ukraine or stop Covid lockdowns in China.

Gas prices across Europe and Asia have come down in recent months, which has helped limit inflation in the UK, but this is because countries have reduced the amount of gas they consume and built up big stocks in storage – temporarily creating a glut. This is nothing to do with the Bank of England. The energy price guarantee, introduced by the government to limit domestic energy prices, has reduced overall inflation – but this also has nothing to do with the Bank.

Food prices, meanwhile, are continuing to skyrocket. Russia’s invasion of Ukraine severely disrupted sales of grain from two of the world’s biggest exporters. Meanwhile, extreme weather, like this summer’s searing heat across Europe, has damaged harvests. Next year’s harvests are expected to be poor too because of further extreme weather and a shortage of fertiliser, therefore the uncertainty will continue.

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Britain imports just under half the food it eats, so rises in the prices of different foods worldwide will turn pretty quickly into changes in the prices of foods on the UK’s supermarket shelves. Food prices alone have risen, on average, 14.6 per cent in the past year.

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Those running the Bank know they can do nothing about all of this. But given its mandated target of 2 per cent inflation – laughably lower than the current 10.1 per cent – and with only one primary lever to pull to get there, it has little choice but to act. The MPC’s choices are further constrained by the pressure being exerted on interest rates across the world by America’s central bank, the Federal Reserve, which has been grinding up its own rate. This is substantially responsible for the decline in the value of the pound – making those essential imports much more expensive.

So the Bank pulls on the lever. The mechanism is pretty brutal, but there’s no great secret to it. The hope is that high interest rates will clamp down on domestic spending, worsen the recession, and so frighten workers (via the threat of unemployment) into accepting lower wages. It’s unlikely to work. More plausible is that we will end up with a recession, while inflation remains very high – the “stagflation” of the 1970s, but in much worse global conditions.

The failure here is systemic. We can no longer pretend that the central bank alone is competent to deal with inflation. There needs to be better coordination between government’s fiscal policy and monetary policy. Subsidies and price controls on key goods and services, like household energy, are clearly now part of the mix – but can only be administered by government. A rewrite of the Bank of England’s mandate, recognising that it, alone, cannot end inflation, is sorely required.