Politics & Paranoia

And so, with barely a flicker of interest from the UK’s economics journalists (page 15 in The Guardian), on Tuesday 14 July the Brown government abandoned the central plank in its economic policy: viz. that the Monetary Policy Committee (MPC) of the Bank of England would keep inflation at or below 2% by using interest rates. On 14 July the governor of the Bank of England announced in the Bank’s annual report that the MPC had not raised interest rates as the inflation rate rose recently because to do so would have required a ‘large increase in interest rates with such a severe impact on output and employment that it would have risked inflation falling well below the target further out.’

The second half of that sentence is pure horseshit – a feeble excuse with which the governor, Mervyn King hopes to persuade commentators not to notice that the policy is kaput. Let us unpack this.

The policy of keeping-inflation-down-with interest-rates worked (when it worked) in two ways: higher interest rates depressed the economy, transferring money from the citizens who had debts to the moneylenders who owned the loans (if more income goes into loan repayments less gets spent on goods), and creating unemployment (the poor spend less). Falling demand pushes down prices through the normal supply and demand market mechanism. Higher interest rates also push the price of imports down because higher interest rates push up the value of sterling and imports get cheaper. (Speculators want to put their money into sterling if it has a higher return that its rivals, such as the dollar and the euro.)

The economists (and the politicians in their thrall, such as G. Brown) like to pretend this is scientific and such, but how much of an interest rate rise will produce this or that much of a reduction in inflation one year? two? down the road is all guess work. They just know that putting up interest rates will eventually reduce price rises in the economy.

In the current situation there is another factor at play. For whatever reason the economists and their politicians have lumped together all price increases as ‘inflation’. In fact this is not true: some price rises, such as the recent increases in world raw material prices are just …..price rises and are beyond the control of this (or any) government. Strictly speaking, inflation is what we get when too much money is chasing too few goods. (Hence the famous dictum of the monetarist economists of the 1970s and 80s that inflation is always a monetary phenomenon; and thus the Thatcher government’s failed attempts to ‘control the money supply’.)

In this society the best recent example of inflation has been the housing market where an uncontrolled frenzy of credit creation has pushed up – inflated – house prices to absurd levels. (Conveniently housing costs are mostly not recorded in the government’s index of consumer prices.) What we have in the world economy now and for the foreseeable future is too many people chasing scare commodities, notably oil and cereals.

The belief that you can control domestic inflation in an increasingly globalised economy solely with domestic interest rates was an absurdity from the getgo and this government was only able to get away with it for so long because the massive expansion of the Chinese and Indian economies flooded the West with cheap goods which kept down the consumer price index, the measure of inflation.(While doing massive damage to Western economies, but hey, that’s the wonder of globalisation!)

Those economies’ demands for raw materials is now putting up prices all over the world, rises in basic commodity prices will cause further price rises in the production/consumption chain and most of us in this country (and all over the world) are going to get poorer; and there is nothing this government can do about it.

And so we arrive at one of the central questions: do messrs. Brown and Darling understand any of this? Did then Chancellor of the Exchequer Brown understand this when he handed over control of interest rates to the Bank of England on his second day in office and abandoned any attempts to control the British economy? Since we have no information on this I can only guess; and my guess would be that having been taught ‘the magic of the market’ nonsense by academics at Harvard in his summer holidays while Shadow Chancellor in the 1990s, Brown really did believe that the bankers had a magic lever they could pull which would control inflation and everything else could be safely left to the market.

(Darling’s views on economics are a blank, as far as I’m concerned. He has written no books or pamphlets on the subject and what he believes – who knows?) Your guess is as good as mine as to the stories they are telling themselves these days as the British economy goes into recession.

This entry was posted on Tuesday, July 15th, 2008 at 11:13 pm and is filed under Economic Policy. You can follow any responses to this entry through the feed. You can leave a response, or trackback from your own site.