I once compared the constant background noise of economic statistics that we are supposed to digest to the rattling of a stick along a set of iron railings. Ratatatatat. The inflation rate, wage rises, public sector debt, house prices – they come rattling out but how do they interrelate and what do all they mean for us? Why do they all seem to be moving in different directions?
Of late, the stick has apparently been wielded by a hyperactive toddler, desperate to get the maximum rat for his tat. The numbers are all over the place. It is worth looking at three of these factors in particular:
- Interest rates, as set by the Bank of England.
- The inflation rate, as measured by the Office for National Statistics.
- The impact of the promised tax cuts from the two remaining candidates for the Tory Party leadership.
I have been speaking to several people I used to know in the City who are qualified economists. I cannot remember a time in recent years when their views have been so far apart. I will try to explain, in a way I hope is understandable to the lay reader, why this is so. Many will disagree with me.
Raising interest rates
Andrew Sentance is a former member of the Monetary Policy Committee (MPC) of the Bank of England, which sets interest rates. It is fair to say he knows about a thousand times more than I do about economics. I am strictly an amateur.
Andy recently published an article in The Times, where I used to work, urging for a rise in interest rates to choke off inflation. “The inflation cat is now well and truly out of the bag, which requires more decisive action from the MPC…That needs to start at the August meeting next week.”
As it happens, I disagree with Andy and have said so to him. As an amateur.
The MPC is due to meet tomorrow. It will review what needs to be done on interest rates to combat rising inflation.
The Bank has a target of 2% for its annual inflation rate. Its own projections, as the above piece suggests, are for 11% by October.
Conventional economic theory suggests that interest rate rises are the usual method to combat rises in inflation. The first reason is technical; rising inflation reduces the relative return on UK public debt, making this less attractive to overseas investors. This puts pressure on the value of sterling.
Increasing rates redresses this. That doesn’t much matter in the current climate. But increasing rates also sucks money out of the economy. You pay more for your mortgage or bank borrowings, so you have less to spend in the shops. If less money is chasing the same amount of goods, prices should fall or at least stabilise.
Inflation in the 1970s, when higher rates were last used to combat it, was driven by the power of the unions, who said, inflation is X percent. Our members want X percent too. This set off a spiral. Inflation hit 25 per cent. Base rates hit 17% in November 1979. The interest rate weapon worked.
Why increasing interest rates won’t work
There are, I think, three reasons why higher base rates will not work again.
One of the factors that allowed inflation to fall then was record unemployment which took the pressure off those wage demands.
But today we face a shortage of workers that suggests mass unemployment will not return. There are, the Office for National Statistics reports, about half a million people who have become “economically inactive”, not yet at the normal retirement age but not working or seeking work.
The reasons for this are numerous and debated, but in the area where I live, a prosperous part of Suffolk, employers are desperate to find staff, especially in the hospitality industry, in pubs, restaurants and hotels.
Factor two: globalisation. It is hard to find figures for this, but in the 1970s and 1980s manufacturers were outsourcing production to the Far East, China and Taiwan in particular. This was a long-term trend that also put downward pressure on prices, especially for electronic products. Everyone around then remembers how the prices of video cassette recorders and hi-fi goods tumbled. Inflation statistics include such goods.
That long-term trend no longer applies, while today, the emergent middle classes in countries such as China, India and Nigeria want the luxuries we have enjoyed for decades. The pressure on prices, I would argue, is in the other direction.
Factor three: the number of pensioners in the UK currently stands at about one in five. In 1991 it was less than 16%. This may not look like a huge change. Pensioners, though, tend to be immune to interest rate rises, because they tend not to have mortgages and bank debt.
Raising rates disadvantages borrowers
Those with private pensions tend to do better, instead, because they are more likely to have money invested as part of those pensions. So rising interest rates benefit the older, and disadvantage those with borrowings or mortgages.
Let’s move on to inflation. This should be bad for anyone on a limited income and unable to put pressure on employers to raise their wages.
It also disadvantages the elderly, who may rely on earnings from those investments above that are whittled away by the falling value of money. (You see what I mean about everything moving in different directions?) If you are getting 1% at best from the bank and losing 10% of your assets from inflation, you are losing almost a tenth of your assets in real terms each year.
More from Martin Waller
True; but the Government has just agreed to raise the state pension by 10%. The mechanism whereby the rate of increase is complicated, the so-called “triple lock”, and it was set aside for technical reasons last year. The decision to raise it by the appropriate amount this year was a difficult one, and I think was wrong. Many hard-up pensioners will disagree.
Truss & Sunak’s tax-cut proposals
Finally, let’s look at the effect of the tax cuts promised by the two candidates. There is a good if lengthy summary here, but broadly, Truss is keen to limit corporation tax. The argument is that this will encourage companies to invest, so boosting the economy. There is precious little evidence for this – companies tend to react to higher profits by rewarding shareholders.
Last week Shell announced a huge increase in quarterly profits because of high energy prices. I can see little in its statement to promise that this windfall would lead to massive new investment in oil and gas fields.
Instead, shareholders were rewarded with a $6 billion share buyback, which boosts the value of their holdings. Other oil companies have done the same.
Let’s look at personal taxation. Again, Truss has been more bullish on tax cuts. The argument is that if people are left with more money to spend, this will help alleviate the cost-of-living crisis. Tax cuts will appeal to those Tory party members choosing between the two, and indeed, Truss is ahead in the polls. There are two problems here.
Tax cuts tend to benefit the well off and higher earners, for obvious reasons. Meanwhile the less well-off will see less benefit and will be impacted by those interest and mortgage rate rises. They may end up poorer.
Second, tax cuts are also designed to stimulate the economy, by giving people more spending power. This would be the consequence if those wealthier pensioners indeed become wealthier. Yet as we have seen, rising interest rates are designed to do the exact opposite.
It is as if you have a tyre that is dangerously over-pressurised. You undo the valve to let air out. Yet you are simultaneously pumping air in the other side. Economically, this makes no sense whatsoever.
Tax policies for members not the economy
Those policies are intended to appeal to that Tory member base, from whom Sunak and Truss need 100,000 or so votes to win. They are probably the last thing the UK economy needs at this stage, in my view.
Finally, let’s set up a counterfactual. Let’s assume that in a parallel universe Sunak and Truss are leaders of two opposed parties standing for election. Of their three main policies, tax cuts leading to more austerity, sending more and more migrants to Rwanda and a “war on woke”, how many do you think would be contained in either manifesto aimed at the ordinary voter?
Yet this is what they have to promise to become the next Prime Minister. It seems an odd way of selecting the leader of our country.