The politics of inflation bears some uncanny resemblances to the politics of Brexit. The EU referendum divided the UK into a southern metropolitan camp and a northern industrial camp. Inflation opens up similar divides. The poor are, of course, more affected by inflation than the rich. What’s new is that the rise in inflation risks political misjudgements of a kind similar to those that led to Brexit.
I know of many economists, especially on the left, who have a relatively low regard for the goal of price stability, and who would like central banks to focus on growth and employment. They regard the fixation with price stability as bourgeois. This mindset dates back to the 20th century, when Keynesian economics was associated with policies that favoured the working classes. Back then, the main economic trade-off was between inflation and unemployment. Workers suffered from unemployment, but much less from inflation. In the 1970s, trade unions were able to negotiate above-inflation wage deals. Wealthy people, by contrast, were more affected by inflation. Back in those days, the right hated inflation, and the left hated the policies deployed to fight it.
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Today, the picture is totally reversed. The poor and low-income earners have the greatest interest in stable prices because the decline of trade union power means they have no one to look after their interests – except for the central bank.
Middle- and higher-income earners, by contrast, have more ways to protect themselves against inflation than they used to. They no longer hold their wealth in cash or bank deposits, but in property or stocks. Their biggest risk is the high interest rates needed to bring inflation down.
Between these two periods, there was a brief interlude – from around 1990 to 2020 – in which a consensus emerged that low inflation would benefit all. The argument went like this: we all agree on the goal, so may as well leave the details to the experts. It was the golden age of macroeconomics and central bank independence.
That age is coming to an end, as central banks have failed to deliver on the deal. They are still independent, but the broad consensus on which their independence rests is changing. Monetary policy has become political again. It started with the global financial crisis, when central banks adopted quantitative easing, the purchase of government bonds. During the pandemic, they bankrolled fiscal stimulus. It was the age in which central banks discovered the art of the possible. In the process, they made the owners of financial assets richer.
Now they stand accused of making the poor poorer by allowing inflation to rise. They are not to blame for the supply-chain shortages during the pandemic or for Vladimir Putin’s war. Price shocks happen. Their mistake was underestimating the knock-on effects and failing to react.
They raised interest rates eventually – belatedly and reluctantly – and continue to feed expectations that the worst will soon be over. Interest rates are still below the levels of underlying inflation in the eurozone and the UK. This suggests that the central banks are betting on inflation coming down by itself. Their fast and furious reaction to the global financial crisis stands in marked contrast to their complacency about inflation today.
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Most at risk, in my view, is the UK, a medium-sized country with a large financial sector. Andrew Bailey, the governor of the Bank of England, often gives the impression that he prioritises financial stability while only paying lip service to inflation targets. Even in the best of times, central banks face trade-offs between low inflation and financial stability. This phenomenon is known as financial dominance. It is what stops them today from raising interest rates to 6 per cent – or whatever it takes to get inflation back to 2 per cent. Rates that high would risk a housing market crash, and trigger a financial squeeze; maybe worse. It would turn into a middle-class nightmare.
Contrast this with the late 1970s. When Margaret Thatcher came to power in 1979, her government raised interest rates to 17 per cent by November of that year. It was middle-class England that voted her into power. Today, it is the middle class and the media that are demanding the Bank of England proceeds with caution.
Some economists even want the central banks to raise the inflation target, arguing that the pain of reducing inflation to 2 per cent would be too great. In other words, they want to move the goal to where the ball is going. And they are trying to dress this up as technical necessity – as opposed to what it really is: a political choice.
The re-politicisation of monetary policy brings us back to Brexit. EU membership, the single market, and financial integration in Europe benefited some more than others. Those in the metropolitan political bubble failed to see this. Something similar is happening in another area. The policy advocacy of the left no longer works for the constituency of the left.
We should therefore not be surprised if new political parties or groupings were to emerge with an agenda to take back control – from the central banks. We have seen a first step in that direction in Australia, where the government clipped the wings of the central bank’s governor for failing to address inflation in time. The Reserve Bank of Australia is still independent, but this episode should serve as a warning to central bankers everywhere that their status is not assured. The same may happen at a central bank near you.
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This article appears in the 17 May 2023 issue of the New Statesman, The Left Power List