Imagine you are a trade union official deep in negotiations with an employer over pay. Inflation is running at 10% and you know the company has lots of unfilled vacancies. You are seeking a wage settlement that at the very least maintains the spending power of your members.
The backdrop to the pay talks is a war that has led to a sharp rise in the cost of energy. Gas and electricity bills have gone up, leaving members of your union with less disposable income.
Then up pops the chief economist of the Bank of England to say that you should really just grin and bear it, accept the fact that the nation has become poorer as a result of the energy shock and move on.
In those circumstances, do you say: “You know what, the bloke at the Bank of England is talking a lot of sense so I will moderate my pay claim from 10% to 5% in order that inflation doesn’t become embedded?” Or do you ignore what the Threadneedle Street official says and carry on pushing for a double-digit increase?
Obviously, this is not just conjecture. Huw Pill, the Bank of England’s chief economist, made the case last week for workers and companies to show restraint. People in Britain, he said, needed to accept that they were worse off as a result of the energy shock caused by Russia’s invasion of Ukraine.
At one level, Pill was right. If the cost of the goods a country imports goes up by more than the price it is able to charge for its exports then – in the aggregate – that nation’s spending power is reduced. That was true during the oil shock of the early 1970s and it is true today.
But the idea that workers and businesses are going to show voluntary restraint is for the birds. In the 1970s, governments imposed statutory prices and incomes policies in an attempt to ease inflationary pressure, which were unpopular and – ultimately – ineffective. Pill seems to be suggesting that employees and employers should agree a self-imposed voluntary prices and incomes policy to make it easier for the Bank of England to bring inflation back to its 2% target.
It’s important to understand what’s going on here. The Bank initially thought the inflation that followed the end of lockdown was temporary. At the end of 2021, just before the Russian invasion, Ben Broadbent, one of the Bank of England’s deputy governors, thought there was a “good chance” that the higher prices caused by supply bottlenecks would have “dissipated” by the time any increase in interest rates could take effect.
Five months later, the Bank’s governor – Andrew Bailey – had a less reassuring message. Inflation was forecast to rise to a 40-year high and “to say there isn’t a lot we can do about it is an extremely difficult place to be”.
In the intervening period, the Bank’s view fundamentally changed. Inflation could no longer be guaranteed to prove transitory. Indeed, there was a risk it could prove hard to shift. That meant there was a risk the Bank’s previous breezy confidence that price pressures would soon fade could come back to haunt it.
Ever since, the Bank has been conducting a thinly disguised back-covering exercise. This had a number of strands. It means saying the current high level of inflation is primarily the result of global forces beyond the Bank’s control. It also means arguing that the Bank’s response to the pandemic – the cut in interest rates to a record low of 0.1% and the creation of money through the process known as quantitative easing – did not stoke the inflationary fire.
In a long speech last week, Broadbent said it was wrong to blame the pickup in inflation on the QE programme during the pandemic. Finally, it involves stressing that should inflation become embedded it will be the fault of wage bargainers and price gougers, not Threadneedle Street’s monetary policy committee (MPC). Pill is clearly gearing up to vote for higher interest rates when the MPC meets again next week.
There has been plenty of pushback against the Bank. Paul Nowak, the TUC general secretary, said in response to Pill’s podcast remarks that workers needed a pay rise not lectures, and there was also plenty of criticism from free-market economists. Julian Jessop, the former chief economist of the Institute of Economic Affairs, said Pill’s remarks were “insensitive” and added to the sense that the Bank was “asking households and businesses to control inflation, when that’s its job”. Jessop added there was little evidence of a wage-price spiral.
What’s all the fuss about? Two things, really. First, the days of permanently-low inflation guaranteed by an ever-more integrated global economy are over. Second, the Bank now seems to be assuming that getting inflation fully out of the system will take time and won’t happen without some pain. Headline inflation, as measured by the consumer prices index, is likely to come down sharply when the April figure is released towards the end of May, but core inflation, which excludes items such as energy and food, will prove harder to shift.
Stephen King, a senior economic adviser to HSBC bank, puts it well in his excellent and readable new book about the re-emergence of inflation* when he says an independent central bank that fails to deliver price stability is bound to come under greater political scrutiny.
“Indeed, arguably one reason why many central bankers have been so keen to insist that the rise in inflation during the pandemic and following the Ukraine war was temporary – and thus had nothing to do with their own policies – was the fear of admitting error.” Far better to blame someone else.
*We need to talk about inflation by Stephen King (Yale University Press).